Media reports have overhyped the new Term Funding Scheme (TFS), under which the Bank of England will supply medium-term funds to banks at Bank rate as long as they maintain or expand their lending.

Some reports have described the scheme as a “giveaway” or “subsidy” to banks. It is not. The Bank will fund the scheme by creating new bank reserves, which earn interest at Bank rate. The net cost of the scheme to the Bank (ignoring administrative expenses), therefore, will be zero. There is no “giveaway”.

Usage of the scheme, according to the Bank, “could reach around £100 billion”. Some reports have added this figure to the £70 billion of planned purchases of gilts and corporate bonds, claiming that the Bank has launched a £170 billion “money-printing package”. Usage, however, may fall well short of £100 billion, while the scheme will be used mainly to replace existing funding, not to finance new lending. It is not equivalent to QE.
 
Many banks are holding “excess” reserves at the Bank relative to their regulatory or operational needs. These banks could use these reserves, earning Bank rate, to exploit any profitable lending opportunities – they have no need or incentive to access the TFS. Their lending, therefore, is unlikely to be affected by the scheme.

The scheme is targeted at liquidity-short banks and building societies, which will be able to use it to replace more expensive wholesale and retail funding and, possibly, to increase lending*. The positive impact on the margins of these institutions, however, comes at the expense of not the Bank but rather their wholesale / retail depositors, whose funds will earn lower rates elsewhere.

Even these banks / building societies may have reservations about accessing the scheme, since Governor Carney has suggested that the Bank will expect to have a significant say over their loan pricing decisions. The banks, he said, have “no excuse” not to pass on the quarter-point Bank rate cut in full and the Bank “will be watching” to ensure that they do.

The combined impact of the Bank rate cut and TFS, therefore, may be negative for banks – margins of banks with excess reserves may be squeezed, while those accessing the scheme may lose autonomy over other decisions affecting their profitability. The scheme is unlikely to stimulate much additional lending. Its main effect will be to increase the pass-through of the Bank rate cut to borrowers and, particularly, depositors.

*To the extent that profitable lending opportunities exist that have not been exploited by banks with excess liquidity.