"Funding for lending" hopes to turn sinners into saints In the last month, rules governing how much banks must hold as cash or near-cash have been relaxed, a new state-backed liquidity facility has been launched, and - from Aug 1 - lenders will be offered taxpayer-subsidised funding. Altogether, the package could amount to a £250bn lifeline for the banks. Throw in the additional £50bn of money printing unveiled this month, which helps banks indirectly by boosting deposits, and the measures begin to look like a co-ordinated bank rescue. This bail-out, though is not for the banks, it's for the economy. Since October, when the eurozone troubles became a full-blown crisis, the UK has been in recession, and the Bank of England reckons the squeeze in lending is at least partially to blame. After retrenching for two years, banks were beginning to increase loans again before the eurozone crisis escalated. Since then, the credit crunch has resurfaced. Lending has fallen and borrowing costs risen. Mortgage rates, according to the Bank, have climbed half a percentage point simply due to "uncertainty associated with the problems in the euro area." Small businesses and first-time buyers have been denied loans or offered unaffordable deals. According to a Bank report, "some firms were unable to obtain credit at any cost" and resorted to raising money from "wealthy individuals." The "funding for lending" scheme is the authorities" attempt to stem the worst of the credit crunch in the UK. The problem has been that, as the euro has eroded confidence in banks, their cost of funds has increased, which has been passed on in higher rates or withheld credit. Effectively, the Bank has intervened to bring banks" costs down by subsidising them. What it hopes is that competition will ensure the subsidy is passed through to customers, just as if funding costs had fallen naturally. If every penny was passed on but the overall level of debt left unchanged, the scheme would deliver an £800m economic stimulus by lowering costs for households and businesses. The scheme will let UK banks and building societies swap troublesome debts for cash-like Treasury bills for four years for a fee. The fee starts at 0.25pc if they maintain or increase UK lending, but rises gradually to 1.5pc as they reduce lending. If lending falls beyond 5pc, the bank gets no benefit. The scheme will initially lower the cost of funding on £80bn of bank loans by around 1pc, or £800m. The subsidy, and potential economic stimulus, rises if lending increases, but falls if it decreases. It is an ingenious plan. The more lending a bank does, the bigger its interest margin and the easier it is to outprice rivals. Subsidising UK loans will also encourage banks to refocus on the home market. But there is a flaw. If there is little demand for credit the stimulus will be minimal. Moreover, credit decisions will remain with the banks and they may not want to lend to small businesses and households any more than before. As the Institute of Directors said: "Only time will tell if the scheme is a success."