A public-private partnership? Central bank funding and credit supply
Summary
Focus
We study how central bank funding affects bank lending. We focus on the United Kingdom's Funding for Lending Scheme. This programme gave banks access to low-cost funding if they continued to lend to households and firms. Combining detailed data on banks' lending flows and funding sources, we assess how and why the scheme's surprise announcement and subsequent amendment affected lending to households.
Contribution
Central bank lending facilities have become a common tool to support credit to the real economy. Yet there is debate about their side effects. Some argue that central bank funding may crowd out private funding without stimulating lending to the real economy and while transferring private risks to the central bank.
We provide new evidence against these concerns. We show that central bank funding acts as a backstop by supporting lending without funds being used. However, we also show that designing lending schemes in a way that provides stronger incentives for banks to lend to specific sectors can weaken this backstop effect.
Findings
Contrary to the notion that public liquidity is primarily a substitute for private liquidity, we find that banks that are more exposed to stress in private wholesale funding markets use less central bank funding. We rationalise this pattern by establishing an "equilibrium channel" of public liquidity. The mere availability of central bank funding reduces the cost of private wholesale funding. This stimulates lending by banks exposed to wholesale funding, regardless of whether they actually use the central bank funding. Using a surprise amendment to the design of the scheme, we show that the strings attached to central bank funding weaken its impact on lending.
Overall the results suggest that central bank funding can support credit supply while strengthening, not weakening, private markets, but that there is a trade-off between maximising benefits for credit supply and targeting specific sectors.
Abstract
We exploit the surprise announcement and subsequent amendment of a central bank funding scheme to test how public liquidity provision affects credit market outcomes. Contrary to the notion that public liquidity is primarily a substitute for private liquidity, banks that are more exposed to stress in private wholesale funding markets use less central bank funding. We rationalise this pattern by establishing an "equilibrium channel" of public liquidity. The mere availability of central bank funding reduces the cost of private wholesale funding. This stimulates lending by banks exposed to wholesale funding, regardless of whether they actually use the central bank funding. Using a surprise amendment to the design of the scheme, we show that the "strings attached" to central bank funding help to explain why it is an imperfect substitute for private funding.
JEL Classification: E52, E58, G21
Keywords: central bank funding, mortgage lending, bank funding risk
