LONDON -- In order to get banks lending again and to fund cheaper credit for British businesses and consumers, the Bank of England and HM Treasury launched the Funding for Lending scheme (the FLS) on 13 July.
Big banks get cheap loans
The scheme works by allowing banks, building societies and other lenders to borrow from the Bank of England for up to four years at an ultra-low rate of 0.25% a year. In return for providing collateral (assets such as business loans or mortgage) as security, banks can access a line of cheap credit from the Bank. The FLS runs for 18 months, from 1 August 2012 until 31 January 2014.
The idea behind the FLS is that -- flush with fresh, cheap cash -- banks will lower their interest rates and thus boost lending. The more that banks lend, the more they can borrow from the Bank of England. In addition, banks that reduce their lending will pay higher rates than those that increase their lending.
Having launched last month, the FLS seems to have got off to a decent start. Five of the U.K.'s six biggest lenders have signed up to it and begun accessing this line of cheap credit. The only major bank not to join the FLS is global giant HSBC, which is already awash with cheap funding.
In total, 13 banks and building societies have signed up to date, allowing them to borrow up to a twentieth (5%) of their existing loan books from the FLS. More lenders are expected to join in the coming months, including building societies large and small.
On the other hand, critics of the FLS argue that lowering interest rates won't raise lending. Instead, they argue that lending is declining because of a severe lack of demand from businesses and individuals. They believe that unless it lifts demand for credit, the FLS is doomed to fail.
Lloyds captures cheap cash
One bank looking to grab a large chunk of cheap cash is Lloyds Banking Group (LSE: LLOY.L ) (NYSE: LYG ) . With around 440 billion pounds of eligible loans on its balance sheet, Lloyds could draw down as much as 22 billion pounds from the FLS.
Earlier this month, Lloyds took an initial £1 billion from the FLS, after launching its "Lloyds Funding for Lending loans" two weeks ago. This gives new applicants a 1% discount on Lloyds' usual lending rates for the life of their loans, with a minimum loan of 1,000 pounds.
António Horta-Osório, chief executive of Lloyds, said, "This initial [1 billion pounds] is just the start. We are committed to helping Britain prosper by encouraging investment and supporting businesses and households with the best possible terms through Lloyds Funding for Lending."
Higher margins boost profits
Following bailouts exceeding 17.4 billion pounds, Lloyds is two-fifths (40%) owned by taxpayers, so it is desperate to return to profitability.
The good news is that by borrowing at 0.25% a year from the Bank of England and lending to businesses and home buyers at high multiples of this rate, Lloyds can boost its net interest margin (NIM). This key performance indicator for banks is the spread between bank funding costs and lending rates.
In its latest half-year results released on 26 July, Lloyds reported a group banking NIM of 1.93%. This was lower than 2.12% in the first half of 2011 and 2.01% recorded in the second half of last year.
With any luck, borrowing cheaply from the FLS and lending at attractive rates to consumers will halt the ongoing decline in Lloyds' NIM. Indeed, if drawn down in full, this extra 22 billion pounds of cheap cash could -- with any luck -- send Lloyds' NIM rising once more.
A snapshot of Lloyds
With Lloyds about to get another shot in the arm from taxpayers, is now a good time to buy its shares? Let's quickly check its fundamentals:
||28.2 billion pounds
|Forecast price-to-earnings ratio
|Forecast dividend yield
Source: Digital Look.
At Tuesday's closing price of 40.62 pence, Lloyds shares offer a tiny forward dividend of 0.1% and are priced at a steep rating of nearly 25 times earnings. Also, they trade at 60% of book value, which is a lot higher than they have traded at many points in this post-crash era.
What's more, given the near-20% rise in Lloyds' share price over the past month, I reckon they've gone far enough for now. Hence, I'm not a buyer at these levels, as there are better bargains elsewhere.
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Cliff does not own any of the shares mentioned in this article.