Why Funding for Lending Scheme figures should be taken with a pinch of salt

The Bank of England announced yesterday that net lending has fallen by £2.4bn despite introduction of the Funding for Lending Scheme (FLS). By its own metric, the scheme has failed. However, our banking reporter Tim Wallace has written on how these statistics fail to capture the full story:

Together RBS, Lloyds and Santander have seen net lending fall by £14.3bn since the middle of last year, according to the Bank of England’s figures. Yet all three have increased SME lending, while the bailed out pair are giving more first time buyers mortgages – so how can that add up?

RBS and Lloyds have been actively refocusing on their core markets: UK retail and business lending. That means cutting back in other areas like commercial property. So even though Lloyds increased SME lending by four per cent last year, and RBS hiked core lending by £1bn in the past six months, that was outweighed on the FLS measure by cuts to non-core lending.

Santander’s problem comes from new regulatory hurdles, particularly those targeted at cutting risky lending. The bank is also rebalancing, shifting away from its traditional base of mortgage lending and into SME loans, but new capital rules mean that for every extra pound the institution wants to lend to SMEs, it has to cut five pounds from its mortgage book. So it too is contributing to growing firms and the real economy, but the FLS figures make it look like the bank is cutting back.

(Full article)

So while the banks are getting on with what they are supposed to be doing, lending to those in the real economy, there are now calls to change the FLS to boost the net lending figure. Its importance has been exaggerated.

Intervention in lending (specifically in housing) had a large part to play in the crisis of 2007-8. While prices should work like traffic lights, signalling when to stop or go, cheap credit turned all the lights to green. The co-ordination that price signals are meant to provide was lost, and markets crashed.

What is important is that price signals can work, and the FLS distorts those. Distorting the price of credit means that risk can't be priced appropriately.