In 2012, the Bank of England launched a Funding for Lending Scheme (FLS) to provide stimulus to the housing, and subsequently SME sectors, with strong documented impact. Under the scheme the Bank effectively lent to the banking sector at preferential interest rates, contingent on the commercial banks making new loans to the designated sectors.
Our proposal? A Green Funding for Lending Scheme. If the environment of close to zero interest rates prevails, implementing a system of ‘dual interest rates’ as outlined below provides limitless scope for further monetary support, deployed to targeted sectors – in this case greening energy, transport, buildings, construction – without compromising the independence of the Bank of England or relying wholly on fiscal policy.
How would a GFLS work? A number of central banks, including the Bank of England, the European Central Bank (ECB) and the Bank of Japan (BoJ) have embarked on targeted lending programmes through the banking system to provide additional stimulus.
These programmes have two major advantages over conventional monetary policy. They can be targeted at specific areas of the economy, where investment is required – for example:
– The BoJ’s programme aimed at reconstruction in the area of Japan most affected by the 2011 Fukushima nuclear disaster.
– The European Central Bank has shown that there are no limits to this form of stimulus. During the Covid pandemic, the ECB has left official interest rates unchanged but has cut the interest rate on its targeted lending scheme further into negative territory. Under this scheme banks can borrow at interest rates as low -1%, subject to them providing new loans to the economy.
The Bank of England could launch a new programme at substantially negative interest rates, perhaps starting at -2%. To be clear, this would not affect money market rates, deposit rates or mortgage interest rates. This interest rate would only apply to loans made under the GFLS. The Bank would make loans available to the commercial banking system fixed at these interest rates for up to five years, on condition that the banks extend loans to finance investment in sustainable energy development.
To safeguard operational independence, the Bank of England would be responsible for the timing, quantity, implementation and pricing of these loans. However, as with the original FLS, cooperation with the Treasury would be required. The necessary criteria for assessing which investment projects qualify as either eligible sustainable energy investments or significant regional development projects would need to be determined by Ministers. It would then be down to commercial banks to determine which specific projects to lend to. Government would set the overall criteria for eligibility, but the private sector would play a dominant role in execution.
It is important not to underestimate how powerful this policy could be. For example, the UK is already meeting approximately 20% of national electricity demand from onshore and offshore wind energy, and capacity can be built from start to finish within less than five years. These are relatively low-risk capital investments, with predictable returns based in part on guaranteed revenues. Under a Green Funding for Lending Scheme (GFLS), loans could be made from the Bank, fixed at -2% for five years, the industry would be supercharged and capacity could be doubled. This level of ambition would provide both substantial immediate stimulus to the economy and contribute to the UK’s carbon targets. It would ensure a more balanced economic recovery, led by capital investment and could transform energy sustainability in the UK, and role model catalysts for the rest of the world.
The same programme could be extended across green infrastructure, from solar power, to auto-finance for electric vehicles, to charging infrastructure. The most rapid and effective way to accelerate the take up of electric vehicles is to create a significant pricing differential in their favour. A GFLS aimed at green investments could achieve this.
In addition to sustainable energy investments, there could be a Regional Funding for Lending Scheme (RFLS) for which commercial bank funding at negative interest rates would be made available for investments made in targeted regions for “levelling-up” in the UK.
We identify three criteria for success of this programme.
1) Ease of implementation: It must be easily identifiable whether an investment project is eligible. The Bank of England and the Treasury would need to draw up clear and transparent criteria for eligibility – which the commercial banks implement.
2) Transparency of benefit: The Bank of England will also require evidence from commercial banks that the preferential funding terms they are receiving are being substantially passed on to end borrowers. This could be done by either referencing existing credit facilities a borrower has obtained, or market interest rates for equivalently-rated borrowers.
3) Design of separation of powers: This facility must preserve the operational independence of the Bank of England, and protect the separation of monetary and fiscal policies. The Bank would be responsible for the quantity and price of money being created to finance this stimulus.
On an an ongoing basis, this form of targeted monetary policy may eventually be deemed preferable to a policy centred on a single money market interest rate and asset purchases.
ENDNOTE: Setting the interest rate substantially below bank rate would be an innovation for the Bank of England. Prior schemes provided funding at close to Bank Rate. There is no practical or theoretical reason why Bank Rate should be the floor, as the European Central Bank has demonstrated. Were it not for the existence of the effective lower bound and the threat of a reversal rate, Bank Rate itself would be a lot lower. A steeply negative GFLS rate would be closer to the r*, and therefore not a subsidy. Arguably the rate on these facilities should be much lower, perhaps -4% or -5%. This should be determined by the BoE, subject to its inflation target. As recent research suggests, concerns regarding the effect on the Bank of England’s should be secondary to the importance of delivering on its inflation-targeting mandate.