Can Cheap Money Beat the Profitability Paradox?

The big financial news in the UK today is that the Bank of England will give around £80 billion to UK banks at below-market rates, for them to lend to consumers and businesses. The government expects this "funding for lending" scheme to expand lending, thereby stimulating the economy and helping to lead the UK out of its current recession (or, as the government puts it, “the present period of heightened uncertainty”).

Sounds good, but the wrinkle in the plan has already emerged. In an article today, BBC News business editor Robert Peston described the cautions he’s hearing from banks:

“First, they say creditworthy businesses and households are reluctant to increase their debts in these uncertain times. Second, many of the companies and individuals desperate to borrow are those in some financial difficulties, so the banks don't actually want to lend to them.”

Sound familiar? Yes, it’s our old friend the Profitability Paradox.

It will be interesting to see the banks’ response, since the risk of the new loans stays with them, not the government. The government has made the support contingent on “the performance of banks in sustaining or expanding their lending to the UK non-financial sector.” In other words, no new loans, no cheap money. So we shall see if cheap money is enough of an attraction to get banks past the Profitability Paradox.