WHAT IS FUNDING FOR LENDING?
Roy Davidson, 13 November 2020
The Reserve Bank of New Zealand has announced a Funding for Lending programme, providing a new source of funding for banks so that they can lend to businesses and households at lower rates. In this article we answer some commonly asked questions about the new scheme and what effect it is likely to have.
What is Funding for Lending?
Funding for Lending is pretty much exactly what it sounds like – the Reserve Bank of New Zealand (RBNZ) provides loans directly to banks to enable them to lend. This provides a steady source of funds to banks, ensuring that they are able to continue lending even if other sources of funds (like term deposits or wholesale funds) dry up. This funding is also cheap, being provided at the Official Cash Rate, making it an attractive funding source. While further details are yet to be provided, the programme will commence in December, loans will be for a three-year term and available to banks for the next year and a half.
Is this a surprise?
The RBNZ has signalled it would look to implement Funding for Lending for some time. This will add to the OCR cuts that have already taken place, and the quantitative easing (bond buying) programme that has already been enacted.
In addition, the RBNZ has pointed to the Official Cash Rate potentially moving into negative territory next year once the banking sector is operationally ready for it. In fact, the RBNZ has repeatedly said it prefers a negative OCR over quantitative easing. However, with COVID-19 hitting the economy so swiftly earlier in the year, the RBNZ’s hand was forced and it announced a quantitative easing programme.
With Funding for Lending, quantitative easing, and potentially a negative Official Cash Rate, the RBNZ looks could deploy all the unconventional monetary policy measures we saw as possible last year before COVID hit. However, more positive economic news, and should Funding for Lending have the desired effect, could make a negative OCR is less likely.
How big is the programme?
Banks will be able to borrow up to 4 per cent of their outstanding loans. In addition, they can then borrow an additional 2 per cent on the condition that they increase the amount they lend in total (the RBNZ will provide 50 cents for every dollar of additional lending).
The maximum size of the programme to be almost $30bn. For comparison, the RBNZ’s quantitative easing programme is currently sized at $100bn.
What is the goal?
Like all the other actions undertaken by the RBNZ this year, the funding for lending programme is ultimately designed to lower borrowing rates across the economy. A drop in borrowing rates incentivises businesses and consumers to borrow and spend, driving economic activity. The RBNZ Governor noted the impact would be bigger than cutting the Official Cash Rate to 0.10 per cent as the Reserve Bank of Australia has done.
Does the lending have to go towards any particular sector?
Given the property market has been very strong of late, with house prices rising as borrowers benefit from record low mortgage rates, there was some speculation that banks would be required to use funds received as part of the programme for business lending only, not for mortgage lending. However, this has proved to not be the case and the banks can use the funds to lend to any sector. With loan to value restrictions (LVR) not likely to be reinstated until March next year, this may add more fuel to the property fire.
Has this been done overseas?
Funding for lending has been used in several other countries around the world, usually during a crisis when other sources of funds, e.g. via wholesale markets, are threatening to dry up. In fact, the RBNZ quickly provided a smaller ‘Term Auction Facility’ in March this year to alleviate any funding pressures banks faced during peak COVID fallout.
The RBNZ’s Funding for Lending programme will be one of the few to use the tool to help lower interest rates and implement monetary policy. Notably, Australia has a similar scheme (called the Term Funding Facility) though incentivises banks to lend to businesses over homeowners.
Does this mean the outlook for the economy has deteriorated?
We don’t think so. In fact, the economic forecasts released by the RBNZ point to a slightly more optimistic picture with the central bank saying that the economy has, to date, been more resilient than earlier expected, while believing that the risks to the baseline scenario now look less skewed to the downside.
For instance, the RBNZ now sees unemployment peaking at 6.4 per cent (in the June 2021 quarter), down from 8.1 per cent in at the August OCR review (and 9 per cent at the May review). Similarly, it sees house prices increasing by 9.6 per cent for 2020, compared to anticipating a drop of 6.9 per cent in August. Offsetting this somewhat is a still tepid outlook for GDP growth from the RBNZ.
Either way, the RBNZ appears committed to providing the necessary amount of stimulus required to minimise the chances of economic fallout, though this may prove to be not as much as previously expected. Given the better economic picture at present, and the implementation of Funding for Lending, the implementation of a negative OCR is now much less certain.
What does this mean for term deposit rates?
Term deposit rates have fallen significantly this year, and with this announcement, they could fall even further. Put simply, the Funding for Lending programme opens up a new source of cheap funding for the banks. This makes them less reliant on attracting term deposits from investors, meaning they can afford to lower term deposit rates. However, recently we’ve also seen corporate bond yields increase, largely due to positive vaccine news. This may act to soften the blow for investors reliant on income.