Funding for Lending: the right idea, the wrong execution

Posted on 25 Apr 2013

The Government's £80bn Funding for Lending scheme has been extended and has given banks an incentive to lend to SMEs, but are companies even aware of it?

George Osborne yesterday extended the Funding for Lending to January 2015 and, more importantly, gave the banks a real reason to lend more to small and medium sized businesses, which hitherto have not seen much of the money.

Banks have to fund themselves regularly and Funding for Lending is cheap money. Now Funding for Lending has offered an allowance of £10 funding for every £1 a bank can prove it lends to an SME through 2013. In 2014, the ratio will dip to £5 allowance for every £1 to an SME. Mortgages remain the most popular form of lending under the scheme (FLS), because they are standard calculations and lower risk, but this rule change will make a difference.

Read the news and many commentators have written off Funding for Lending. James Barty of Policy Exchange says because banks require more capital to lend money to companies, and they are asked to maintain higher capital ratios on balance sheet, it is the wrong scheme because it makes lending to firms more risky. Rather, he says, the Treasury should in effect underwrite some of the risk to get lending moving.

Duo UK, a £25m turnover manufacturer of plastic packaging, needed to buy a Eu600,000 co-ex machine. Their UK bank didn’t appear to demonstrate its use of the  Funding for Lending in the lending terms it offered. It asked the Italian machine manufacturer to provide the machine via the UK bank as creditor but the Italians said no. Finally, the machine was supplied quickly via a promissory note arranged between the machine maker and its own Italian bank. Finance director Paul Teasdale, speaking to Robert Peston on BBC R4, said it was easier and cheaper this way, and says he sees little evidence Funding for Lending is working.

Commentators have been quick to write off Funding for Lending, but manufacturers should take heart from the new changes, says EEF’s senior economist Andrew Johnson. “It has made bank borrowing, and therefore lending, cheaper; the new terms give banks a real incentive to approve loan applications – or they will simply not get as much cheap funding – and it has only been going since August for some banks, others started later. The problem, as so often with well-meaning schemes, is lack of awareness.”

While the banks know about Funding for Lending, Johnson says there is no obligation to explain to borrowers that they’ve used the scheme to offer cheaper loans. “Banks already send out so much bland marketing literature, often to companies who have become disaffected with banks, and few if any explain this rate is possible due to the Funding for Lending. Companies just see yet another bank offer without being shown it is e.g. one per cent cheaper because of Funding for Lending.” EEF has been lobbying government to establish a single entity responsible for forcing banks to explain FLS to companies better, lest they ignore it in the wash of bank marketing.

While sanguine about Funding for Lending’s effect on borrowing in the longer term, Mr Johnson also points out the fundamentals of the UK banking system are not right for getting money easily to SMEs. More competition is needed, of course, but this necessity took a back step yesterday when the £750m deal to sell 632 Lloyds branches to the Co-Operative Bank failed. There were simply too many branches to take on in such a moribund economy. Johnson says EEF will keep pushing for ways the government can engineer more banking competition, and branch independence, but the Co-op flop shows that this will be difficult.

The next Funding for Lending lending figures will be out in June. Will they show a decent pick-up from the low numbers announced in Feb, as better information and the SME-weighting changes spur a host of companies to pile into their local bank branches demanding an FLS-enabled loan? Or, like Duo UK’s Mr Paul Teasdale, will your company seek non-UK bank finance to enable your investments?

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See also City A.M. reporter James Barty’s critique of the the Funding for Lending Scheme here.