What is Funding for Lending?

We have probably all heard about the Bank of England’s Funding for Lending scheme, but do you actually know what it is?

Funding for Lending allows banks to swap assets such as existing loans with the Bank of England  in exchange for gilts, which they can then use to borrow money for their lending at close to base rate.

They pay a small fee to access the scheme, of 0.25 per cent per year. This will remain the same if they keep grow net lending or keep it stable. If they shrink it the fee will rise by 0.25 per cent for every 1 per cent decline in net lending up to a maximum of 1.25 per cent.

The price of each bank’s borrowing in the Scheme will depend on its net lending between 30 June 2012 and the end of 2013.

Banks can borrow up to five per cent of their existing lending stock, and for every £1 of additional lending made by a bank, it will be able to access an extra £1 of cheap funding from the scheme.

The way the scheme is set up means that with base rate at 0.5 per cent banks can access funding at a rate of just 0.75 per cent and even if they shrink net lending they will not pay more than 2 per cent for it.

Compare this to the lowest available commercial loan rate of around 6-7% and you can see that the margin available to the banks is quite remarkable.  So why are the banks still not lending to small and medium sized businesses?