The Bank of England and Chancellor of the Exchequer recently announced measures to kick start the economy. The objective is to protect UK banks against an escalating Eurozone crisis, pump cash into the financial system and boost lending to businesses and households.
Bank of England (BoE) governor Mervyn King and Chancellor George Osborne both spoke at the Lord Mayor’s banquet on 14th June, and pledged to take “coordinated action” to protect the economy.
UK banks have been finding it increasingly difficult to raise funding through international markets, making it hard for businesses and households to get credit. The BoE and Treasury are now working on ways to lend directly to banks. The full package is expected to be ready in a few weeks. It will provide emergency protection for banks while underpinning lending and reducing the cost of loans for businesses and property owners.
Funding for lending plan
In his speech, King said that “Today’s exceptional circumstances create a case for a temporary bank funding scheme to bridge to calmer times.”
The funding costs for banks have risen with the Eurozone crisis, making it harder to access credit, but this new “funding for lending plan” will now provide funding to banks for several years, at lower rates than available on the open market. Rates will be based on their performance in lending to the UK’s non-financial sector.
Banks will be able to swap the loans they have made to businesses and individuals with the central bank, and must then use the funds to provide new loans to their customers, at affordable rates.
The scheme could provide a £80bn boost to loans and is expected to start within weeks. The central bank will hold the swapped assets for up to four years.
In a BBC radio interview the following day, Treasury minister Mark Hoban said they estimated that if lending increased by 5%, this would be the equivalent of £80bn. The amount will depend on the take-up and the Treasury believes that creditworthy businesses will find the lower rates made available attractive. "We want to send a very clear signal to businesses that finance is available at a price they can afford," he added.
In his speech King also said that he wanted to make it clear that the BoE will “provide banks with whatever liquidity they require”.
To this end, the Bank will immediately activate an as yet unused facility, the Extended Collateral Term Repo Facility, to provide banks with emergency cash if needed. Liquidity will be offered in tranches, with a minimum of £5 billion a month.
This means that at least £5bn a month should be injected into the financial system. It is believed that around £60bn could be released if necessary.
This scheme will help protect banks from the impact of the Eurozone crisis, as they would not have to rely on international markets to raise funds. It provides a liquidity safety net for UK banks, which would be particularly useful if they suffer rating downgrades and so find it harder to raise funds.
Releasing cash reserves
The Bank of England is changing the remit of the new Financial Policy Committee so that it will now have to focus on growth as well as financial stability. This could reduce pressure on banks to build up capital reserves, something which contributed to their reduced lending.
On 17th June The Sunday Times reported that King “quietly gave permission” for banks to release their capital reserves - even though it was the BoE which had instructed banks to build them up. Since banks will need to keep less on deposit, they will have more funds to lend to businesses and individuals.
This could release another £150billion available for loans, taking the total stimulus package up towards £300bn.
This “could lead to a huge move in the financial markets” as banks could potentially use some of the cash to buy corporate bonds and other financial instruments, helping boost the financial system by moving money from bank balance sheets into the real economy.
The BoE governor gave his strongest hint yet that the Bank may expand its quantitative easing programme. He said that “the case for a further monetary easing is growing”, and that the measures to improve conditions for the banking sector can complement any further easing in monetary policy.
Critics argue that the government and Bank of England have reacted too late, but late is better than never. Any boost for UK businesses should be good news for the economy, consumers and investors. Across the Atlantic it is believed that the US Federal Reserve Bank is also preparing to inject more stimulus into its economy. For advice on an investment strategy designed around your objectives and circumstances, speak to an experienced wealth manager like Blevins Franks.
By Bill Blevins, Blevins Franks Financial Correspondent
18th June 2012