Funding for Lending scheme aims to cut loan costs

media captionGeorge Osborne: "This is a huge help for the British economy"

A multi-billion pound scheme designed to make more - and cheaper - loans and mortgages available to businesses and individuals has been outlined.

The scheme, called Funding for Lending, will see the Bank of England make low-cost funds available to banks and building societies.

The aim is to tackle rising borrowing costs and a drop in lending. Lending has fallen 16% since its peak in 2008.

However, some expressed concerns that not all savings would be passed on.

"The banks may not pass on all that cost advantage they may just take it on wider margins," Graeme Leach, from the Institute of Directors, told the BBC.

"And at the end of the day you know the elephant in the room is the euro crisis and companies and consumers need the confidence to borrow."

Mortgage rates

Banks will initially be able to borrow the equivalent of 5% of the amount they currently lend. But if they increase their lending, they will be able to borrow more.

There is no upper limit on the amount financial institutions can borrow at cheaper rates, but the first allocation is expected to be worth £80bn, or 5%, of the current stock of lending.

"For every pound of additional real economy lending an institution advances, an additional pound of access to the scheme will be permitted for that institution," the Treasury and the Bank of England said.

One of its aims is to bring down mortgage interest rates, which have risen by about 0.5 percentage points in the past year.

One mortgage broker said it was vital that cheaper funding was targeted at the homebuyers who needed it most.

"It is vital that any lending is available in the loan-to-value bands that need it," said Mark Harris, chief executive of SPF Private Clients.

"If funding will only be cheaper and easier for those with, say, a 50% deposit or similar level of equity, for example, there will be little improvement on the current situation," he said.

Carrot and stick

The Funding for Lending scheme will begin in August and will be open for 18 months.

Banks and building societies will be able to borrow, for a fee of 0.25%, over four years. That interest rate is much lower than it currently costs them to borrow on the wholesale markets.

There are penalties built in to the scheme, as well as incentives. If, even despite the cheaper funding, the financial institutions still cut the total amount they lend, the Bank of England will charge them more, up to a maximum of 1.5%.

Chancellor George Osborne said he hoped it would support households and businesses "at a challenging time" .

He said uncertainty caused by the eurozone crisis was "contributing to increased funding costs for UK banks and tighter credit conditions for households and businesses".

The scheme "will support the flow of credit to where it is needed, complementing the MPC's asset purchase programme in easing monetary policy conditions", he said in a letter to Bank of England governor Sir Mervyn King.

Labour shadow Treasury minister Chris Leslie said the plan did not go far enough.

"To address the biggest problems in our economy... we need a change of course from the government on tax rises and spending cuts which go too far and too fast.

"Only a credible and balanced plan for jobs and growth that gets our economy moving again and people back to work will succeed in getting the deficit down," Mr Leslie said.

The Bank of England (BoE) will publish the amount lent to firms and households every three months.

The British Chambers of Commerce (BCC) gave the scheme a cautious welcome, saying it was keen to see how the scheme worked in practice, and urged the government to go further.

"We will be watching closely to see if this has any positive impact for new and growing businesses, which have largely been frozen out of the market for finance in recent years," said BCC policy director Adam Marshall.

"As [the BoE and the Treasury] roll out Funding for Lending, they should be even more radical and plan for the creation of a bona fide business bank in the medium to long-term."

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