The impact of quantitative easing on UK bank lending: Why banks do not lend to businesses?

Abstract

The growing proportion of UK bank lending to the financial sector reached a peak in 2007 just before the onset of the Global Financial Crisis (GFC). This marks a trend in the dwindling amount of bank lending to private sector non-financial corporations (PNFCs), which was exacerbated with the Great Recession. Many central banks aimed to revive bank lending with quantitative easing (QE) and unconventional monetary policy. We propose an agent based computational economics (ACE) model which combines the main factors in the economic environment of QE and Basel regulatory framework to analyse why UK banks do not prioritize lending to non-financial businesses. The lower bond yields caused by QE encourage big firms to substitute away from bank borrowing to bond issuance. In addition, the risk weight regime of Basel II/III on capital induces banks to favour mortgages over business loans to small and medium enterprises (SMEs). The combination of lower bond yields and Basel II/III capital requirements on banks, which, respectively, impact demand and supply of credit in the UK, plays a role in the drop of bank loans to businesses. The ACE model aims to reinstate policy regimes that form constraints and incentives for the behaviour of market participants to provide the causal factors in observed macro-economic phenomena.