The Funding for Lending Scheme (FLS) Explained

The Funding for Lending Scheme (FLS) was a Bank of England and HM Treasury programme launched in July 2012 that let banks and building societies borrow UK Treasury bills, posting their existing loans as collateral, in exchange for a fee as low as 0.25% a year. Cheaper fees were reserved for banks that grew their net lending. It was designed to fix a specific problem: cutting the Bank of England's base interest rate is only the first stage of monetary policy; the harder part is getting banks to pass that lower rate on as loans households and firms can actually borrow. This is the bank lending channel of monetary policy transmission, one of several channels, alongside the interest rate channel and the asset-price/portfolio-rebalancing channel, through which central bank action reaches the real economy. When that channel broke down after the 2008 financial crisis, the Bank of England turned to a new generation of unconventional tools. Quantitative easing was the first and best known of these. The FLS was the second, designed specifically to fix the lending channel that QE alone couldn't reach. 

Why the Lending Channel Broke Down 

By 2012, Bank Rate had sat at 0.5% for more than three years, and successive rounds of quantitative easing had pumped hundreds of billions of pounds of reserves into the banking system. Yet mortgage and business loan rates stayed stubbornly high. The gap between the Bank of England's policy rate and the price borrowers actually paid had widened sharply — an unusually weak interest rate pass-through from Bank Rate to the price of loans.

The problem sat on the funding side of bank balance sheets, not in the cost of central bank money. The eurozone sovereign debt crisis had made wholesale funding markets expensive and unreliable, forcing banks to pay steep premiums to fund both new and existing lending. Facing squeezed margins and thin capital buffers, many banks rationed credit rather than expanding it, a form of credit rationing that conventional rate cuts couldn't touch, because the constraint was one of bank funding costs and risk appetite, not the price of reserves.

This is precisely the gap that separates the FLS from QE. QE works by injecting liquidity and lowering yields across the economy; the FLS was a targeted fix aimed directly at bank funding costs and balance sheet capacity, making it a genuine companion tool rather than a substitute.

How the Scheme Worked 

Participating banks and building societies could borrow UK Treasury bills from the Bank of England, posting loans as collateral, at fees as low as 0.25% a year for up to four years. Crucially, both the amount available and the fee charged were tied to each bank's net lending: banks that expanded lending borrowed more cheaply, while those that shrank their loan books paid a higher fee. That link between funding cost and lending performance was the scheme's defining innovation and what distinguished it structurally from QE's broad-based liquidity injections.

Early results looked promising:

• By the end of September 2012 (eight weeks in): drawdowns totalled £4.4 billion.
• By year-end 2012: 39 participating groups, covering over 80% of the stock of lending to the real economy, had drawn £13.8 billion.
• Funding costs: Bank funding costs (measured by five-year CDS premia, the cost of insuring against a bank defaulting) fell markedly in the scheme's first months.

Effects, and the Mid-course Correction

Lending volumes rose, but not by nearly as much as funding costs fell, exposing the scheme's central limitation: cheaper funding doesn't automatically translate into cheaper or greater lending if banks prioritise deleveraging (paying down debt and shrinking their loan books rather than lending it out) instead. Net lending among FLS participants was actually negative at the end of 2012, at –£2.4 billion, even as drawdowns kept growing.

In response, the Bank of England and Treasury recalibrated the scheme in November 2013, extending it into 2014 and stripping out incentives for household lending entirely so that every pound of remaining support was weighted towards SME lending, the segment judged most starved of credit. The FLS was extended further before finally closing in January 2018.

Even after the 2013 SME reweighting, net lending to businesses stayed negative through 2014, and an OECD-published study found no clear evidence the incentive change had boosted SME lending specifically. The Bank ultimately judged the FLS a success on the household side, where funding costs fell sharply and mortgage lending recovered enough to end those allowances in January 2014, but its impact on business lending remained much weaker and only showed patchy signs of recovery before the scheme closed. 

Part of a Broader Toolkit

Read alongside the Bank of England's use of quantitative easing and the mechanics of monetary policy, the FLS illustrates a broader post-2008 truth: once interest rates hit their floor, central banks had to design increasingly specific instruments to reach parts of the economy that conventional policy no longer touched.