BoE launches liquidity scheme

The Bank of England is launching a scheme to allow banks to temporarily swap their high quality mortgage-backed and other securities for UK Treasury Bills.

It is hoped the move will help alleviate some of the pressures of the credit crunch. With markets for many securities currently closed, banks have on their balance sheets an ‘overhang’ of these assets, which they cannot sell or pledge as security to raise funds.

Their financial position has been stretched by this overhang so banks have been reluctant to make new loans, even to each other. Under the scheme, banks can, for a period, swap illiquid assets of sufficiently high quality for Treasury Bills.

Responsibility for losses on their loans, however, stays with the banks. By tackling decisively the overhang of assets in this way, the Scheme aims to improve the liquidity position of the banking system and increase confidence in financial markets.

Mervyn King, governor of the Bank of England, said: “The Bank of England’s Special Liquidity Scheme is designed to improve the liquidity position of the banking system and raise confidence in financial markets while ensuring that the risk of losses on the loans they have made remains with the banks.”

Usage of the scheme will depend on market conditions. Discussions with banks suggest that use of the scheme is initially likely to be around £50bn. The scheme will be ring-fenced and independent of the Bank of England’s regular money market operations, so it will not interfere with the Bank’s ability to implement monetary policy.

The British Bankers’ Association welcomed the move, branding it an innovative and unique policy response. It said the banks participating in this arrangement expect it to make a significant contribution to alleviating the pressures in the UK money markets.