The volume of interbank borrowing contracted in April and May despite the introduction of the special liquidity scheme (SLS) by the Bank of England on 21 April.

The SLS is designed to improve access to funding by expanding the pool of high quality collateral against which banks can borrow. However, Bank of England figures released yesterday show that the stock of borrowing from other UK banks – both unsecured and in the form of sale and repurchase agreements (repos) – fell by £23 billion in April and May combined. The annual growth rate of such borrowing has plunged from 24% to zero over the last year – see first chart.

The contraction of activity despite the introduction of the SLS may reflect two factors. First, from the demand side, the scheme has probably had little impact on the cost of borrowing for most banks, reflecting its LIBOR-related fee structure combined with large “haircuts” imposed on the value of banks’ securities.

Secondly, from the supply side, banks’ unwillingness to lend to each other may be more the result of a shortage of capital and associated pressure to shrink balance sheets than concern about counterparty credit risk, which the SLS seeks to address.

Capital constraints and continuing interbank funding difficulties are likely to be associated with a further significant slowdown in broad money and credit growth over coming months, increasing the risk of a recession (see here).

The prospect of a major lending slowdown is confirmed by figures on unused credit facilities, also released yesterday. Credit expansion has recently been supported by borrowers drawing down existing lines but these are not being replaced by new loans. The stock of unused credit facilities contracted 6.3% in the year to May – see second chart.