Incentivising lending to SMEs with the funding for lending scheme : some evidence from bank-level data in the United Kingdom

This study explores the effectiveness of the incentive mechanisms embedded within the UK’s Funding for Lending Scheme (FLS) for banks’ to expand their supply of lending to medium sized enterprises (SMEs). The FLS was announced by the Bank of England and HM Treasury in June 2012, with the aim of improving the supply of credit to the UK real economy. Despite the prevailing low level of risk-free interest rates, UK banks’ funding costs were elevated at the time of the Scheme's introduction, and the intention was to provide lenders with a stable source of lower-cost funding to support credit provision to the real economy. The Scheme’s design built in direct incentives for banks to support lending to the real economy, by linking both the price and quantity of funding available through the Scheme to their lending performance. This paper looks for evidence of the effectiveness of these incentives, exploiting a modification of the Scheme’s design for its extension in April 2013 to help identify changes in credit supply from credit demand. Specifically, the change sharpened incentives to lend to SMEs, relative to larger ones. This facilitates using a difference-in-difference approach, exploiting bank-level data on UK banking groups, to look for a direct impact of incentives on credit supply, considering larger companies as a control group. On the basis of the available dataset, it is not possible to identify that this change in the incentive structure of the FLS directly boosted loan growth to SMEs, relative to large firms, between the extension of the Scheme and the end of 2013. The results seem robust to using different metrics of credit supply. However, the dataset is unavoidably small, both in terms of number of lenders covered and the length of the period after the modification of the design. More generally, reductions in lenders’ market funding costs since the FLS’ introduction may have lessened banks’ incentives to use draw on the Scheme, and so the impact of incentives within it.