FLS and the Bank of England's independence

The UK's Funding for Lending scheme is being changed. The Bank of England and HM Treasury have announced that in future, funding obtained through the FLS may only be used to support business lending, not residential mortgages. And to encourage bank lending to businesses even more, the fees for FLS collateral enhancement are being cut.

There has been much talk of a housing bubble in the UK. Personally I am unconvinced, but there is no doubt that the residential property market is stronger than it was. And more broadly, consumer credit is increasing. Up till now the FLS has not distinguished between categories of lending: it could be used to support any lending, although it was hoped that it would particularly be used for business lending. The Governor of the Bank of England argues that broad support for consumer credit is no longer needed, and that the FLS should now be restricted to business lending. I don't disagree. In fact I think the FLS should have been restricted to business lending from the start.

It is fair to say that as funding costs for banks have been falling anyway due to market conditions - particularly the easing of the Eurozone debt crisis - FLS has become less important as a general funding backstop. And changes to regulation and support also reduce its importance. The Governor notes that the recent changes to the Sterling Monetary Framework will provide all the liquidity that banks need. And the Chancellor commends "this Government's" creation of the FPC, claiming that it will ensure that the "mistakes of the past.....will never be repeated". I can't help thinking that "never" is a very long time....history shows that all regulatory changes are eventually insufficient. There will inevitably be another financial crisis. But the FLS would do nothing to prevent that.

But as Duncan Weldon points out, restricting the FLS to business lending does suggest that the Bank of England has concerns about rising house prices and increasing household indebtedness. And if the result is that interest rates rise on new mortgages and other forms of consumer credit, then it amounts to monetary tightening. No wonder the Chancellor's reply to the Governor appears to have been written with gritted teeth. He had no choice but to be seen to support the Governor's decision, but tightening general credit conditions now could choke off the housing boom that seems to be an important part of his election strategy.

So it seems the Bank of England is testing the limits of its independence. But the real test may come later. With the ending of FLS support for mortgage lending, the Chancellor makes it very clear that he now expects Help to Buy to do the heavy lifting in the mortgage market (my emphasis):
"However, while household credit conditions and the housing market are recovering, the market for higher loan-to-value mortgages remains very restricted by historical standards. This is a significant barrier to first-time-buyers and those without a large deposit.......the Help to Buy scheme is a targeted measure designed to address this specific issue, and its ability to perform this vital function will be unaffected by changes to the FLS, which provides more broad based support for household credit".
The Help to Buy scheme - recently extended to cover existing properties and guarantee mortgage repayments for people trading up - has been almost universally panned, including by the IMF, the OECD and even the Chancellor's own department. The Bank of England has no power to end the Help to Buy scheme, but it does have a responsibility to advise the Chancellor regarding its effect on financial stability. If the FPC were to report, in (say) June 2014, that Help to Buy was inflating the house price market to the point of instability, and therefore should be ended, how would the Chancellor respond? I fear the answer is implied in the quotation above from the Chancellor's letter. My (admittedly cynical) translation:

"Ok, I'll accept you changing FLS, but don't you dare touch Help to Buy until after the election".

In the end, central banks are only as independent as politicians allow them to be.

Related reading:
The fatally flawed FLS
Britain's Money Tree - The Economist
The illusory housing recovery
The FLS early warning system


  1. Money is fungible alert!

    These programs just lower the banks' cost of funding in aggregate and they can lend to whoever they like and the programmes have no impact on banks' portfolio preferences. For hypothecation to matter for a given bank, you'd need category X to be 100% funded by an X-support programme. Is there any major (programme, bank) pair where this is true? I doubt it.

    1. Cig, I think the idea is that a bank's total lending to SMEs will be reviewed ex post and fees or benefits applied depending on whether it has increased or decreased. I can't see how else they can do this.


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