Concerned about the freeze in interbank lending, Bank of England introduces new liquidity facility

A Telegraph article reports that the Bank of England has introduced a new facility to make sterling available to the banking system if UK interbank lending freezes further.

Once again, a central bank treats the symptom of a solvency crisis with liquidity.

The reason that banks refuse to lend to each other is that they cannot tell if the borrowing bank is solvent or not.  They cannot assess solvency because banks are not required to provide ultra transparency.

Without on-going disclosure of each bank's asset, liability and off-balance sheet exposure details, banks cannot assess the risk and solvency of their competitors.  When banks cannot make this assessment, they cannot lend to each other because of concern they may not be repaid.

Another way banks show they do not trust in the solvency of other banks is in the repo market.  Here, the bank with cash to lend requires better collateral and higher haircuts - a higher haircut is another way of saying the lending bank requires more collateral to support a given loan amount.

In the repo market, the symptoms of the solvency crisis express themselves as a shortage of collateral.  This particular problem is exacerbated by quantitative easing which sees the central banks purchasing the better collateral and making it unavailable to the repo market.

The move comes just days after the BoE joined the US Federal Reserve, the European Central Banks and other major central banks to boost the global supply of dollar liquidity by making it cheaper to borrow. 

However the Bank stressed today there was no "short term" shortage of sterling for UK banks. 

The Bank said its new Extended Collateral Term Repo (ECTR) Facility would enable it to offer banks 30-day loans of sterling on an ad hoc basis. 

"There is currently no shortage of short-term sterling liquidity in the market. But should that position change, the new facility gives the Bank additional flexibility to offer sterling liquidity in an auction format against the widest range of collateral," the BoE said in a statement. 

The Bank said its new facility came "in light of the continuing exceptional stresses in financial markets" and that its design had been influenced by feedback from market contacts.... 

The new ECTR Facility will have an auction format, with loans available for 30 days against collateral. 

The BoE accepts as collateral sovereign debt, residential mortgage-backed securities, securitised credit card debt, student and consumer loans and some types of asset-backed commercial paper, amongst other assets.