‘Major break with history’: Is Term Funding Scheme Carney’s most radical tool?


The Term Funding Scheme could be the most critical element in the Bank of England’s £170bn response to Brexit, acting as a transmission mechanism to ensure a 0.25 per cent rate cut and a £60bn increase to QE boost the real economy.

The Bank of England voted unanimously to implement the Term Funding Scheme, which could total £100bn, and in a statement noted it would be difficult for many banks and building societies to reduce deposit rates much further, which could limit their ability to cut their lending rates.

“In order to mitigate this, the MPC is launching a Term Funding Scheme that will provide funding for banks at interest rates close to Bank Rate,” the central bank said in a statement.

It will let banks borrow at the bank rate of 0.25 per cent, but the cost of the scheme will rise for every percentage point that the bank’s lending falls. “Banks would be able to access another pound of funding for every pound their net lending expanded,” the MPC said in its minutes.

It said this would “reinforce the transmission of the reduction in Bank Rate to the real economy” so that the hoped for benefit of monetary stimulus would be passed on to households and firms.

The mechanism, which replaces the Funding for Lending Scheme, has drawn comparisons to the ECB’s Targeted Long-Term Refinancing Operations. Unlike the Funding for Lending Scheme it is funded by newly created central bank money.

“It is definitely designed to be good news for banks, customers and clients,” says Russ Mould, investment director at AJ Bell. “There should be some very cheap financing. It’s going to be cheaper than what you get in the wholesale market, it’s going to be cheaper than what you get in the bond market.”

“People have been worried about margin compression, they’ve been worried about the yield curve flattening. The Bank of England is trying to mitigate some of these challenges by making cheap financing available and letting banks lend on a less risky basis than they would otherwise.”

Bank stocks were up at the end of the day with Barclays up 1.2 per cent and HSBC up 2.3 per cent.

“Long run we’re going to have to see who takes the money up and how much, and then what momentum that provides in terms of credit growth in the UK,” Mould says.

Mould says without the TFS banks have good reason to hoard cheap capital. These include boosting the Tier 1 capital ratios required by regulators, struggling to find creditworthy borrowers, and keeping profits stable as the net interest margin – the gap between interest rates on deposits versus loans – falls.

Eric Lonergan, macro investment fund manager at M&G Investments, says:Carney has very cleverly made some conventional headline changes, while disguising a potentially radical new tool.”

“The cut in base rates and the new QE programme are a sideshow. The new Term Funding Scheme is extremely important,” says Lonergan. “There are now two important policy rates in the UK: base rate and the interest rate at which the Bank of England lends under its TFS programme.”

“This is already a major break with history, when the Bank only lent directly to banks at penal interest rates. In future, there is no reason why the BoE cannot continue to cut the TFS rate and leave Base rates unchanged. In other words, there is no lower bound to the interest rate on TFS.”

Mould says the elephant in the room is debt. “Whether its government debt, corporate debt or consumer debt, the world is more indebted now than it was in 2007.”