OREANDA-NEWS. The Bank of England's GBP100bn Term Funding Scheme (TFS) should partially offset the lower margins at UK banks stemming from the central bank's recent rate cut, says Fitch Ratings. The scheme will provide a new source of cheap funding, but the extent to which lenders can avoid a margin squeeze will be linked to the amount of new lending extended by each bank and the deposit rates they offer.

We expect the majority of lenders to make use of the scheme because its 25bp charge is substantially lower than funding costs in wholesale markets or savings deposit rates. If lenders expand net lending between June 2016 and end-2017, they will be able to access more TFS funds; if lending shrinks, they will not be able to borrow more and TFS funding costs will rise. Banks and building societies can initially use the TFS to fund up to 5% of their existing loan stock. Lenders will be able to pledge assets and borrow four-year money from the BoE.

The TFS will also indirectly reduce funding costs because it will enable banks to force down deposit rates. With the generous-sized scheme, we think competition for deposits will fall and lenders will readily pass on the BoE's 25bp base-rate cut to savers.

Under the BoE's existing Funding for Lending Scheme, the benefit of cheaper funding was dependent on banks increasing their lending to certain sectors. Funding costs fell dramatically and we expect a similar result from the TFS.

A GBP100bn inflow of funding should prove to be ample for anticipated new lending requirements over the short- to medium-term. We also think the TFS will provide the sector with enough cheap funding to offset some pressures arising in the unexpected case that markets become dislocated as Brexit negotiations begin.

The extent of the benefit on net interest margins will be linked to credit demand from borrowers. The direct economic benefit will be reduced if the funds cannot be on-lent. But we still expect some benefit to filter through because savings deposit rates should fall overall and banks should see funding costs reduce as some wholesale funding is replaced with TFS funds.

Our UK GDP forecasts are for growth to slow to 1.7% in 2016 and 0.9% in 2017 - still high enough to support credit demand. But the Brexit negotiation phase is likely to mean that companies might delay decisions on non-urgent investments reflecting greater caution, and consumer spending and housing transactions could slow. We expect any reduction in loan growth in the foreseeable future to be driven by lower demand rather than funding supply given the number of measures introduced by the BoE. The TFS is one of a set of measures to support the economy and preserve financial stability.

The BoE took steps to ensure the banking system has ample liquidity immediately after the Brexit referendum. Regulatory capital requirements have also been reduced slightly through a reduction of the countercyclical buffer and an easing in the leverage ratio calculation.

Compared to many European peers operating in a negative interest rate environment, UK lenders are generally better placed to protect net interest margins. There is still room to lower deposit rates in the UK, whereas many peers already pay nothing for their deposits and would only be able to cut funding costs by charging retail depositors. To date, most lenders have been reluctant to do this.

We do not expect the BoE's measures to impact the ratings of UK banks and building societies.