Bank and Treasury working on scheme to boost funds for firms

Governor Sir Mervyn King used his Mansion House speech in the City of London last night to reveal it is working with the Treasury on the “funding for lending” scheme.

The credit-easing scheme will allow UK banks to borrow at below-market rates, as long as the discounted loans are passed on to non-financial businesses.

The news came hours after the Government backed plans to reform the banking system, so savers and taxpayers never have to “take the pain” again when a bank fails.

Chancellor George Osborne’s long-awaited banking White Paper will create a ring-fence to separate high street banks from their riskier investment banking arms.

The Government estimated the reforms will cost the banking industry up to £7bn a year and the wider economy as much as £1.4bn a year.

But Ministers believe the costs will be outweighed by the benefit of avoiding another financial crisis and bank bailout, which has cost the UK £140 billion.

In his Mansion House speech, Mr Osborne said: “I believe we have found a workable way to solve what I called the ‘British dilemma’ – protecting British taxpayers in a way that does not make the UK uncompetitive as a home of global banks.”

The Bank’s new liquidity scheme follows complaints from businesses that banks are hoarding cash and refusing to lend to all but the safest of firms.

With Britain’s double-dip recession threatening to drag on for longer, this has prompted calls for more action to stimulate growth – including direct Bank intervention in bank lending.

Banks have long argued they cannot significantly boost lending to businesses and build up capital and liquidity buffers at the same time, a situation exacerbated by Europe’s debt crisis.

Sir Mervyn said: “The Bank and the Treasury are working together on a ‘funding for lending’ scheme that would provide funding to banks for an extended period of several years, at rates below current market rates and linked to the performance of banks in sustaining or expanding their lending to the UK non-financial sector during the present period of heightened uncertainty.”

Britain’s central bank has until now avoided direct intervention though offering cheaper credit to banks. Instead, it has held its base rate at the record low of 0.5 per cent and embarked on an unprecedented round of quantitative easing – buying £325bn of mainly Government debt.

But this has proved ineffective in bringing down the real cost of borrowing for households and businesses, with many homeowners seeing mortgage interest rates rise in recent months.

“The measures that I have outlined will support the banking sector, and provide it with incentives to increase lending to the real economy,” said Sir Mervyn. The scheme will tackle banks’ high funding costs directly, and could be in place in weeks.

The Government’s White Paper aims to make banks safer for savers by ranking individual depositors above bondholders and corporate creditors in the event of a bank collapse.

Mark Hoban, Financial Secretary to the Treasury, told Parliament it was “determined to take action to deliver a stable banking sector that underpins, not undermines economic growth”.

However, moves to broaden the range of activities allowed in ring-fenced operations led to accusations from Shadow Chancellor Ed Balls that Mr Osborne was “watering down” reforms.