The Bank of England’s Funding for Lending scheme begins today and aims to provide incentives for banks to lend to businesses and individuals and to provide a boost to the sliding UK property market.
Under the scheme the Bank of England will lend money to banks at below-market interest rates as long as they pass on the money to businesses and individuals in the form of loans.
How the cheaper funding to banks is used will be monitored and if the banks do not increase lending after taking money from the scheme they will be penalised.
As well as providing a shot in the arm to the property market, the new scheme aims to be more effective than the Project Merlin lending scheme in providing loans to small and medium-sized businesses.
The Bank of England would like to reverse the trend that has seen lending to businesses fall by 17 per cent in the last four years.
The Royal Bank of Scotland (RBS) has already indicated that it plans to take advantage of the scheme. It plans to reduce the cost of borrowing by one per cent for customers on £2.5 billion worth of loans.
The scheme allows banks to borrow up to five per cent of their stock of existing lending at just 0.25 per cent for up to four years if they increase their lending. If they do increase lending then they will have access to more of the cheaper funds from the central bank. The 0.25 per cent rate is much lower than rates available to them on the open market.
The Bank of England says that the scheme is "designed to incentivise banks and building societies to boost their lending to UK households and non-financial companies".
The scheme penalises banks that take the cheaper loans but do not increase their borrowing by increasing the cost of borrowing to 1.5 per cent. Any losses will be borne by the banks and not the taxpayer.
The new scheme will supersede the £20 billion National Loan Guarantee Scheme.
As the scheme begins some lenders have already started to cut rates on long-term fixed rate mortgage deals but only for homeowners who have a lot of equity and can put down a 40 per cent deposit.
In recent days HSBC, Santander, Natwest and Barclays have all cut rates and began to offer five-year fixed rate deals charging interest at just 2.99 per cent.
However, so far significant cuts in rates on products for first-time buyers and homeowners with less equity have not been announced.
Ray Boulger of mortgage brokers John Charcol said: "“It is already clear that, in stark contrast to Project Merlin, the Funding for Lending Scheme is very quickly proving effective as far as the mortgage market is concerned.”
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