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The BoE Is Getting "Libored"

Authors: Benn Steil, Senior Fellow and Director of International Economics, and Dinah Walker, Analyst, Geoeconomics
January 30, 2013
Wall Street Journal Europe


A recent Bank of England poll of U.K. lenders turned up some unexpected good news: Credit "availability" for both households and companies rose significantly in the fourth quarter of 2012.

The net proportion of lenders reporting a rise in the availability of secured household credit over the prior three months soared to a post-2007 high of 26.2%, up from negative 4.1% in the second quarter and 21.9% in the third. The positive change was even more dramatic in the corporate sector: Lenders reporting improved credit availability rose to a net of 29.4%, up from negative 5.5% in the third quarter.

The Old Lady of Threadneedle Street was quick to take credit for the credit. "Lenders noted," crowed the BoE, "that the Funding for Lending Scheme," through which the BoE and U.K. Treasury have since August provided banks with ultra-cheap funds to boost their lending, "had been an important factor behind this increase."

It is impossible to know how much banks would have lent without access to reduced borrowing costs from the government. But we can say with confidence that the survey the BoE refers to is about as reliable as Libor.

Libor interest rates, as we all now know, were routinely manipulated by major international banks over recent years. Because the rates were not based on actual trades, and high rates were seen as indicating difficulties obtaining funding, banks were able and had every incentive to report artificially low ones. Banks have admitted to taking advantage of this flaw in the framework and routinely underreporting their cost of funds.

The indexes of credit availability the BoE has manufactured from its surveys are similarly unreliable. They are created by asking bankers amateur-journalist questions such as "How has the availability of secured credit provided to households changed?" and then assigning double the weight to lenders who respond "a lot" versus those who say "a little." There is nothing quantitative about the survey itself. Much more importantly, the banks have every incentive to tell the BoE that funding-for-lending is working swimmingly, and that the government should therefore keep funneling them cheap funds.

Meanwhile, actual U.K. bank lending remains dead as a doorknob. Between October and November last year, net secured lending to individuals declined by £200 million, to a level nearly identical to that a year prior. Net lending to U.K. business declined £2.8 billion, to a level 4.1% below that a year prior.

Importantly, FLS-beneficiary banks, which have borrowed some £4.4 billion under the scheme, have barely increased their lending. FLS-bank cumulative net lending to U.K. households and private nonfinancial companies rose just 0.04% from June to November. Lloyds and Santander, each of which borrowed £1 billion under FLS, actually reduced their lending over the period, by £2.8 billion and £3.5 billion, respectively.

In short, actual U.K. lending data suggest the BoE is being "Libored" by the banks—that is, being fed cheery, made-up credit "availability" numbers to keep their regulator and funder happy.

Might FLS yet prove its worth in due course? We doubt it. The scheme is structurally flawed. It offers banks discounted financing equal to 5% of their base stock of loans with no requirement that they actually increase lending. Putting the subsidy after the fact—essentially paying banks to lend—would address this problem. But this would entail the political cost of making the U.K. government's handout to the banking sector transparent.

In the United States, an August research report by the Federal Reserve Bank of Cleveland offered an appropriately skeptical take on FLS, highlighting the fact that it provides the largest subsidies to the weakest banks—those with the highest cost of funds—and warning that its fiscal-policy-like nature could represent an encroachment on the BoE's independence.

Yet with the minutes from the Fed's Open Market Committee meeting in December noting "still-tight credit conditions for some borrowers" as one of the "persistent headwinds" restraining economic activity, and Chairman Ben Bernanke having earlier said that he was "very interested" in FLS, the Fed might yet be tempted to embrace the idea. It should not.

Mr. Steil is director of international economics at the Council on Foreign Relations and author of the forthcoming "The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order" (Princeton University Press). Ms. Walker is an analyst at the Council.

This article appears in full on CFR.org by permission of its original publisher. It was originally available here (Subscription required).

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