RDP 2022-07: The Term Funding Facility: Has It Encouraged Business Lending? 1. Introduction

The Term Funding Facility (TFF) was introduced by the Reserve Bank of Australia (RBA) as part of a policy package in response to the onset of the COVID-19 pandemic. As information around the severity of the new virus emerged, it became clear that restrictions on activity imposed by governments and significant changes in the behaviour of households and businesses would lead to a large fall in GDP. Moreover, as investors responded to new information about the spread of the virus, financial markets experienced a period of dysfunction, raising the possibility that finance would be difficult to access for an extended period, exacerbating the economic downturn.

On 19 March 2020, the RBA introduced a range of measures to lower funding costs and encourage the provision of credit, thereby supporting economic activity: a reduction in the cash rate to 25 basis points; a change in the rate of remuneration of exchange settlement balances to 10 basis points; a target for the 3-year yield on Australian Government Securities (AGS) of around 25 basis points; an increase in the amount and term of repo operations; and the TFF.

The TFF provided authorised deposit-taking institutions (referred to hereafter as ‘banks’) with access to low-cost funding for a term of three years. The facility had three key objectives:

1. Support the banking sector to continue to extend credit to households and businesses at a time when wholesale funding markets had been significantly disrupted.
2. Lower funding costs for banks and, in turn, reduce borrowing rates for their business and household customers.
3. Encourage banks to increase their lending to businesses, particularly small and medium-sized enterprises (SMEs).

Banks were granted an ‘initial allowance’ equivalent to 3 per cent of total credit outstanding, to be drawn by end September 2020. The cost of funding under the TFF was well below the cost of funding in wholesale markets. By providing banks with an assured source of funding at low cost, the TFF achieved the first two objectives above. To address the third objective, the TFF also granted an ‘additional allowance’ to those banks that expanded their business credit relative to a pre-pandemic baseline.

On 1 September 2020, the RBA announced that the deadline for TFF drawdowns would be extended to 30 June 2021 and provided a further supplementary allowance of 2 per cent of credit.

The TFF provided banks with an assured source of funding and lowered their funding costs, both directly and indirectly. The TFF reduced funding costs directly because it had a lower price than alternative sources of funding at the same term. Notably, it provided funding to all eligible lenders at the same rate, and so effectively was more advantageous to lenders with higher costs of funding (lower credit ratings). In addition, the TFF led to lower funding costs through various indirect channels, including by causing the supply of bank bonds to decline, which reduced bond spreads and increased the level of deposits held at banks (Kent 2021b; Black, Jackman and Schwartz 2021).^[1]

Furthermore, lower levels of bank bond issuance caused spreads on asset-backed securities (ABS) to decline, as investors sought securities with similar credit risk, thereby benefiting non-bank lenders (Figure 1). Non-bank lenders are finance providers that do not accept deposits, such as finance companies and money market corporations. The reduction in banks' funding costs flowed through to lower interest rates charged to households and businesses, with the largest declines for rates for larger businesses and new fixed-rate housing loans (Figure 2). It is clear that the TFF reduced banks' funding costs and led to lower interest rates throughout the economy. The focus of this paper, however, is on the third objective of the TFF: namely, whether the TFF supported business lending.

This paper attempts to estimate the causal effect of the TFF on the amount of banks' lending to businesses. The facility may have supported lending by providing banks with an assured source of funding, by reducing their funding costs, and/or by providing an incentive to increase lending so as to increase their additional allowances. We investigate the effect of the TFF on business lending through these three channels. The first set of our regressions aims to identify only the effect of the additional allowance on credit supply to businesses. In subsequent regressions, we aim to capture the broader range of channels, including the effect of the TFF on lending volumes via lowering banks' funding costs and increasing funding certainty. In these latter regressions, we first estimate the overall effect on business lending of the TFF being available to banks, and then estimate the effect on those banks accessing the facility. In all regressions, we use a difference-in-differences approach. The identification strategies rest on assumptions about the relationship between different types of lending in the absence of the TFF or in the absence of the additional allowance feature. We clearly state these assumptions, along with why they may not hold, at the relevant parts of the paper. We also aim to increase the robustness of the results using additional control variables, instrumental variables, and a triple-difference framework. To the extent that these strategies do not fully address the identification challenges, it is possible that our results understate the effect of the TFF on business lending.

The questions addressed in this paper have important policy implications for central banks. Term funding schemes have been introduced in many countries in the past two decades, with several of these including incentives to encourage specific types of lending, typically to businesses. A wider range of central banks introduced or expanded term funding schemes in response to the COVID-19 pandemic. Most of the existing literature on central bank term funding schemes relates to the European Central Bank's (ECB's) targeted longer-term refinancing operations (TLTROs), which have been found to be generally effective in promoting increased lending to businesses. Literature on other central bank funding schemes remains scarce. This paper seeks to contribute to this literature, building our understanding of term funding schemes and their potential to encourage the provision of credit. This body of evidence, including this paper, is likely to be useful as central banks consider the design of future term funding schemes, should they be pursued.

This paper does not provide a detailed assessment of all aspects of the TFF. As mentioned, other work has described how the facility provided banks with funding certainty and contributed to lower funding costs for banks, which flowed through to lower interest rates for households and businesses (Black, Jackman and Schwartz 2021). So it is important to emphasise that this paper is focused only on the effect of the TFF on the quantity of bank lending to businesses, including SMEs.

This paper is structured as follows. Section 2 describes the TFF in detail, before discussing take-up of the facility and trends in business lending. Section 3 describes the various term funding schemes used by other central banks and the evidence for their effect on lending. Section 4 describes the lender-level data used, while Section 5 explains the identification strategies and challenges. Sections 6, 7 and 8 outline the regressions and results. Section 9 concludes and provides a discussion.

Footnote

This is because when bank bonds mature, banks repay bondholders by crediting their account with deposits. See Kent (2018) and Doherty, Jackman and Perry (2018). [1]