Wednesday, 24 April 2013

Funding for Lending for Dummies

For those following the UK developments you may have heard trumpeted the news that the fabled Funding for Lending Scheme (FLS) is being extended to January 2015. But few understand what it is, or what it does.

And importantly what it doesn't do.

So I thought I'd try and shed some light on the system.

  1. FLS is a discount window that banks are less embarrassed to use. There is huge embarrassment about the discount window in the UK - primarily because it has only just been invented here. Prior to 2008 there wasn't really one in place, and after that the banks have treated it like the financial version of an STD clinic. In contrast the FLS offers a good chunk of four year money at a very low rate to those who fulfil the criteria and the government sector is encouraging its use. 
  2. FLS is really 'funded' by HM Treasury. As you can see from the graphic above the 'money creation' is actually initiated by HM Treasury - in that they create the 9 month Treasury Bills and lend them to the Bank of England, who then lend them onto the FLS participant. Conveniently that doesn't show up on the Bank of England balance sheet, as it's a 'Stock Lending Transaction'. See how the consolidated government sector MMT analyses is used when required, despite all the Wizard of Oz style smoke and mirrors about 'central bank independence'.
  3. FLS differentiates between different loan types. Banks get access to more funding if they increase their lending over time and even more cheap funding if they lend or cause certain others to lend to SMEs. Which is of course a form of central planning. Bang goes the efficient capital allocation of financial markets theories.
  4. Funding for Lending is more Lending for Funding. Less driving the amount of 'real world' lending forward and more desperately trying to stem the retreat. MMT analysis tells us that so long as the margin between the return on the loan and the rate they would have to borrow from the central bank through the discount window is sufficient, a bank will lend. The continuing retreat in lending suggest that the problem is lack of demand at the current price - even with funding costs suppressed by FLS.
  5. FLS is about setting a limit. The amount of money drawn down from FLS is less important than its expectation effect on the rest of the debt market. The cost of risk funding had been rising prior to the widening of the discount window in this way. Widening the window has returned the cost of risk funding to near what it was previously. 
  6. FLS does not affect bank capital. The discount window is a collateral upgrade system. You pledge risky assets and get less risky assets in return - which increases your liquidity. It does nothing about your solvency though. As far as I can see Treasury Bills don't add to regulatory capital, which means that the amount of lending is still capped by the price of obtaining that regulatory capital in the market.
  7. FLS demonstrates that its all about the width and depth of the discount window. How much further does this market manipulation have to go before the powers that be realise that central banks hold interest rates up and set corridors as required. And therefore by far the most rational approach is simply to disintermediate the entire process, with the central bank providing all the bank funding required to those who will narrow their banking business to underwriting those capital projects required by society.