Another string to the BoE
The Bank of England is tooling itself up. The UK central bank announced on Dec. 6 a new facility to help domestic lenders if the euro zone crisis causes a fully-fledged freeze in short-term funding markets. But banks may still need more help.
The BoE already has two ways to combat liquidity squeezes. It allows banks to borrow against liquid collateral for three or six months through its Indexed Long-Term Repo (ILTR) auctions. And it allows desperate banks to swap illiquid collateral for gilts for up to a year via its Discount Window Facility (DWF) – in return for a fat fee and big haircuts.
In some senses, the new Extended Collateral Term Repo facility (ECTR) is a halfway house. It uses a similar auction structure to the ILTR but allows banks to pledge DWF-style collateral for a minimum fee of 125 basis points over the BoE’s base rate. As such it goes some way to filling the gap left by the now-defunct Special Liquidity Scheme (SLS), the crisis facility which allowed UK banks to swap illiquid mortgage-backed securities for liquid Treasury Bills for a period of up to three years.
However, the ECTR will only last for thirty days at a time. That may help avoid a collapse, but won’t provide much long-term reassurance. Contrast the BoE’s approach with the European Central Bank, which is currently being pressured to offer facilities that last for two or even three years. Even though the UK is not in the euro zone, its banks are suffering from the same long-term funding drought as their rivals on the continent. That’s worrying because, according to the BoE’s own figures, UK lenders have to roll over 140 billion pounds of term funding next year.
But the central bank has rightly judged that providing long-term bank funding is not its job. That is a task for the UK government, which could re-open its Credit Guarantee Scheme, a 250 billion pound programme that allowed banks to weather the 2008 crisis by issuing new long-term debt insured by the state.
Unlike many European countries, a UK sovereign guarantee still carries credibility – 10-year gilts are currently yielding just 2.3 percent. Now that the BoE has donned its fire-fighting kit, HM Treasury should tool up as well.