THE BANK of England yesterday made an almost unlimited offer to acquire UK banks' mortgage-backed securities for up to three years in return for treasury bills.
Mervyn King, governor, said the plan would "take the liquidity issue off the table in a decisive way". The plan is designed to support banks' liquidity rather than their solvency.
The facility will be open for six months and the Bank of England expects to swap £50 billion (€62 billion) in assets in the first couple of months.
This figure could rise sharply as commercial banks rush to offload loans on to the central bank for a period of at least one year, renewable for a further two years.
It is a radical action that the central bank believes will remove fear that a solvent bank will not be able to settle its debts. It should therefore unblock the interbank lending market.
Federal Reserve officials will consider a similar long-term liquidity scheme if it eases UK financial strains. The European Central Bank had no comment.
Mr King told journalists the scheme had three principal elements: to raise liquidity, protect taxpayers and avoid distorting the mortgage market.
It would support long-term liquidity by swapping high-quality AAA-rated mortgage-backed securities for government paper for up to three years.
Risk to UK taxpayers would be minimal because banks retained liability for defaults on assets and would be offered considerably less in government paper than the market value of assets. The haircut on an own-brand long-dated mortgage-backed security would be 27 per cent.
The central bank would not refinance new mortgage lending.
British chancellor Alistair Darling has told MPs that the Bank of England's latest operation will help resolve problems in the wholesale financial markets and in turn assist businesses, individuals and the mortgage market
The bank does not have a fixed amount of government paper on offer, but expects about £50 billion to be demanded from banks, making the liquidity scheme twice as big as its existing three-month lending against mortgage-backed securities, which it started in December.
That lending has proved successful, but not sufficient to address the liquidity problems of Britain's big banks, which are hoarding cash and have what the Bank of England describes as an "overhang of assets, which they cannot sell or pledge as security".
Initial indications are that the conditions on the bank's special liquidity scheme are more draconian than expected and the price the banks must pay for the new facility - a cross between a temporary purchase of assets and a loan - will be quite steep.
This might lead to a lack of demand for its use by the banking sector or stigma being attached to the lending programme, but should ensure that taxpayers are not exposed to any significant risks of losing money.
Shares in the UK's banks fell following the publication of the details of the scheme and sterling was also weaker, having risen at the end of last week when details of the plan began to emerge.
The pound fell 0.5 per cent to $1.9883 against the dollar, lost 0.5 per cent to Y205.95 against the yen and slipped 0.8 per cent to £0.7976 against the euro.
The three-month sterling Libor rate fell slightly from Friday's fix of 5.89375 per cent to 5.885 per cent, still well above the bank's base rate of 5 per cent.
Martin Slaney, head of derivatives at GFT, said: "The market reaction at least in the short term may well be one of disappointment that further funds have not been earmarked as part of a more long-term plan. We are a long way off from returning to a more liquid lending market where mortgages are freely available."
Another analyst said: "The facility is helpful but the haircuts make it more onerous than expected for banks to participate. The funding gap remains much larger than this facility."
- (Financial Times service)
