The FLS does not seek to allocate credit to particular parts of the economy directly – the Bank is not taking a view on this matter. But SMEs and first time home buyers in particular are thought to be credit hungry. Banks will collectively need to meet that demand if they are individually to make the most of the FLS. 10  BIS central bankers’ speeches  Not necessarily every bank will support every sector. But if the big firms don’t then the smaller banks will. We are relying on the pressures of demand and supply, and competition, to ensure that credit flows to where there is demand. The normal business model of a bank is that their lending rates are related to their funding rates. The process for doing so is not immediate and funding from different sources – both retail and wholesale, secured and unsecured, might be used to support lending activities. There is no reason to think that the provision of cheaper funding via the FLS will cause a bank to change its business model in this regard. Indeed the incentives in the scheme are for banks and building societies to cut lending rates and hence lend more to get the cheapest funding. Since the scheme was announced we have seen widespread falls in funding costs across different sources and an equally wide variety of lending rate reductions.
One could put off deciding on new rules – but the uncertainty would then still act as a drag. The best course seems to be to design and publish the new frameworks but delay their implementation. Even this isn’t entirely satisfactory – the market will reward firms who meet the rules early as they will be perceived to have the strongest balance sheets. Competitive pressure will encourage weaker firms to accelerate their own process so as to keep up, possibly reducing the benefits of a relaxed timetable. The answer to these practical problems of policy making is perhaps in the following key point: the new regulations should be designed as far as possible to be counter-cyclical so that they are less demanding during a crisis such as now, than at other times. Buffers are there to be used. If capital and liquidity buffers could not be used during the bad times then they serve no purpose: they would just be a deadweight loss on the banking system, shifting the point of failure for a firm to a more expensive and hence less efficient location. Putting this in concrete terms, the Financial Policy Committee recently recommended to the FSA that it make clear that the new liquidity buffers introduced by the FSA in 2010 may be used in part, in the event of a liquidity stress, without regulatory over-reaction. Firms don’t need to treat the FSA guidance as a hard minimum and hold an extra buffer on top.