The Bank of England (BoE) is understandably touchy about its £50 billion (Rs3.98 trillion) emergency liquidity funding for UK banks being called a bailout. But a bailout is what it is—and it’s the biggest bailout BoE has embarked on since the 1970s. BoE has effectively agreed to become the funder of last resort for the broken UK and European mortgage and credit card securitization markets for the next three years. Although structured as a swap for presentational purposes, the aim is to pump fresh money into the banking system in the hope this leads to lower inter-bank rates and more lending.
The good news is that there are enough safeguards in BoE’s bailout operation to ensure taxpayers aren’t too badly exposed and that the banks don’t get an entirely free lunch. The pool of eligible collateral is the same that BoE currently allows for its three-month auctions. It will accept triple A-rated UK and European asset-backed securities subject to a haircut of up to 22%, depending on maturity. And while the facility is available for up to three years, banks will have to replace any collateral that is downgraded, or top up its collateral if asset values fall.
The arrangement has been structured to try to encourage banks to improve inter-bank lending. The facility comes with a punitive fee of the spread between the London inter-bank offered rate, or Libor, which is the rate at which banks must currently fund these assets, and the general collateral rate at which banks can fund government securities. That is an incentive to banks to reduce Libor. Similarly, BoE will impose a 5% extra haircut on banks looking to swap their own mortgages, which should encourage trading.
Whether this will be enough to improve liquidity in the inter-bank lending market remains to be seen. BoE is keen that all banks should make use of the facility to reduce the stigma. It also says it will extend the size of the facility above £50 billion if there is sufficient demand. Banks will also be allowed to package up old mortgages written before December into new securities to take advantage of the new facility. Even so, it does not go as far as many banks had hoped, in terms of the range of eligible collateral, so the overhang in the market will remain.
Meanwhile, the basic premise for this bailout still remains questionable. There is still some risk to taxpayers, which is why the Treasury has had to indemnify BoE.
And while it suits BoE to claim the collapse of the securitization market is the result of problems in the US, European traders are clear they regard UK mortgage securities as every bit as dodgy. It is not obvious why boosting lending into an already overinflated market is a quicker way to end the crisis than allowing prices to find a floor.