Central Banks Launch Funding for Lending Programs
The Yale Program on Financial Stability has produced and will continue to update a spreadsheet to assist those contemplating Central Bank Funding for Lending programs. The spreadsheet catalogs past and current examples of crisis-focused funding for lending programs, identifies interesting program features, summarizes existing evaluations of programs, and shares general resources on the topic. This spreadsheet can be accessed here (Current version as of 3/24/2020 for those unable to access Google Sheets).
Also, access our live “financial-intervention” tracker, which is a single point-of-entry on the YPFS website to keep up with financial-crisis fighting interventions by central banks, fiscal authorities, and international organizations here.
As societies implement social distancing in response to the COVID-19 pandemic, millions of small businesses are experiencing catastrophic revenue declines and temporary closure. Governments across the world are responding with a range of programs to prevent systemwide bankruptcies.
Central banks have adapted their traditional lender-of-last-resort function, the discount window, to encourage banks to lend to small businesses. In this post, we compare four such “funding for lending” programs that we have identified in the current coronavirus crisis: Australia, the United Kingdom, Saudi Arabia, and Taiwan. We also discuss two earlier, similar programs: the Bank of England’s Funding for Lending Scheme in 2012 and Hungary’s Funding for Growth Scheme in 2013.
Incentives to Lend to SMEs
The principle that distinguishes a funding for lending program from a traditional discount window facility is the stipulation that banks use the funds to lend to small or medium-sized enterprises (SMEs). Discount window loans do not typically come with conditions on how banks use them.
Funding for lending programs can also offer financial incentives. For example, the current UK and Australian programs are split in two tranches. All eligible banks have access to the first tranche, but banks can only access the second tranche if they use the first tranche to increase their loans to SMEs. The drawdown windows for the two tranches don’t have to be the same. In Australia, the first tranche is available until September 2020 and the second tranche is available until March 2021. The Bank of England did not include a multi-tranche incentive structure in its 2012 program. However, it introduced such a structure when it extended the program in 2013.
The current Bank of England program includes an additional incentive to encourage lending. Its 0.00% participation fee (due at the end of the program) goes up to 0.25% if the amount of net lending decreases (the fee went all the way up to 1.50% in the 2012 program).
Size of Program
The Bank of England set no upper limit on the overall size of either the 2012 or the current program. Banks borrowed £42 billion (roughly $67 billion, 2.5% of the UK GDP in 2012) through the original program between June 2012 and April 2013. Other central banks have announced a maximum size for their programs. The Reserve Bank of Australia set its program at A$90 billion ($52 billion, or 4.8% of GDP); Hungary, HUF 750 billion ($3 billion, or 2.2% of GDP); Saudi Arabia, SAR 13.2 billion ($3.5 billion, or 2.5% of GDP); and Taiwan, NT 200 billion ($6.6 billion, or 1.1% of GDP). Still, the amount of funds available to each bank depends on the size of its loan portfolio.
The more banks use the first tranche to lend to SMEs, the more funds will be available to them in the second tranche. Australia uses a formula: funds available to a bank in the second tranche will be the sum of the amount it increased lending to large businesses and five times the amount it increased lending to SMEs in the first tranche.
Eligibility
Typically, only companies with prior access to a central bank’s discount window are eligible to participate in funding for lending programs. This is due at least in part to the pre-existing technical and operational capacity of institutions already in the central bank system. Similarly, rules about eligible collateral and haircuts are normally patterned on existing lending facilities.
Central banks are finding ways to expand eligibility, however. The Reserve Bank of Australia said in announcing its program that it had developed a complementary program for nonbank lenders. In the earlier Hungary program, depository institutions that were not directly eligible could access the program through other banks.
Timing
To encourage banks to begin lending to SMEs as soon as possible, funding for lending programs can reward banks for the lending they had extended to SMEs even before the central bank had made the funding available. This is accomplished by using a date before the crisis began as the date by which the central bank will begin counting new lending. For example, in the current crisis, the UK used December 31, 2019 and Australia used January 31, 2020. This ensures that banks that were already lending to SMEs before the central bank announced its program but after the crisis began benefit appropriately.
Central banks typically set the maturity of the loans for longer than the expected length of the crisis: four years in the UK’s current program, three years in Australia’s. Taiwan has set its loans at six months.
Pricing
An interesting feature of the Taiwanese and Hungarian programs is an interest rate ceiling on the rate banks are allowed to offer the SMEs. The ceiling is set at 1.00% above the borrowing rate (0.125%) in Taiwan and was 2.50% above the borrowing rate (0.00%) in Hungary. The UK and Australian programs did not have interest rate ceilings.
One study found that the Bank of England’s 2012 Funding for Lending Scheme had a positive peak effect of 0.8% on GDP.
See: Central Bank Funding for Lending programs Resource Guide(Current version as of 3/24/2020 for those unable to access Google Sheets).