The Budget contained headline-grabbing announcements on banks and pensions. But there’s been little commentary on the chancellor’s declaration that “the government is against unfair subsidies wherever we find them”. This immediately got me thinking about some of the disparities in the financial system and, in particular, the Funding for Lending Scheme (FLS).
It’s almost exactly three years since the Bank of England and Treasury introduced the FLS, with good intentions. As liquidity had dried up, it was an emergency measure to boost lending to households and small businesses by channelling cheap funding to banks and building societies. Cheaper credit would stimulate the economy by helping people to buy homes and firms to finance growth or working capital.
Regardless of whether the scheme has worked, it has certainly had unintended consequences. Most notably, the impact on savers has been severe. As the FLS reduced banks’ need to attract retail deposits, interest rates fell sharply and haven’t recovered. Bank of England data shows that the average rate on instant access savings accounts was just 0.38 per cent last month – considerably lower than the rates on peer-to-peer platforms like RateSetter.
Fundamentally, the FLS is a form of subsidy to banks, allowing them to access money at below-market rates, add a margin and lend on. This was justified in the aftermath of the crisis, when government money was needed to keep credit flowing. But three years on from the FLS’s inception, with a stronger economy and the advent of market-based solutions such as peer-to-peer lending, government money risks crowding out private sector funds and leads to an artificially low rate of finance compared to open market commercial rates. This distortion surely no longer passes the chancellor’s test on unfair subsidies.
Despite competing against cheap government funding, peer-to-peer lending has proved to be a viable mechanism for connecting private funds with businesses and individuals looking for credit – sustainably and without subsidies. The British Business Bank, which seeks to support small business finance, lends significant sums to businesses through peer-to-peer platforms – and does so, crucially, at commercial, open market rates. More lending like this will help peer-to-peer grow from a drop in the ocean to a useful funding mechanism for the economy as it faces the challenge of weaning itself off artificially cheap credit.
It’s not only the end of the FLS next January that will be the catalyst for this. Buried in the small print of the Budget was confirmation that a new Isa for peer-to-peer lending will be available in April 2016. This will put everyday investors’ money on peer-to-peer platforms on an even tax footing with other investments, and will encourage extra liquidity to be lent to businesses and individuals. As state funding gradually withdraws in a post-crisis world, a new innovative approach will start to plug the gap. All of this at commercial rates and with value going directly to the investors providing the funds.
Three years ago, the Parliamentary Commission on Banking Standards said that “a level playing field between mainstream banks… and alternative providers is required.” We are heading in the right direction and could soon see a very different landscape for funding.