September 5, 2008 / 12:18 PM / 11 years ago

UK urged to clarify funding support for banks

LONDON, Sept 5 (Reuters) - Pressure is building on the Bank of England (BoE) to set out how it will provide funding support to Britain’s banks amid mounting concern that the end of the current scheme in six weeks will tighten the screw on lenders.

Analysts speculate Britain’s banks may have borrowed 200 billion pounds ($352 billion) from the BoE under an innovative Special Liquidity Scheme (SLS) launched in April, but the central bank plans to close the window on Oct. 20.

It is looking to replace it with a more permanent arrangement, but has not said how it will work.

That has stoked concern bank funding will stay tight and become more expensive as securitisation markets remain closed, and has contributed to a fall in UK bank shares this week.

Shares in HBOS HBOS.L, Britain’s biggest home lender and with the largest funding gap between loans and deposits, have dropped 12 percent to 279 pence this week. Lloyds TSB (LLOY.L), Barclays (BARC.L) and others have also sagged and the UK bank sector .FTNMX8350 has lost 5 percent.

The European Central Bank, which also provides funds for UK banks, on Thursday unveiled plans to tighten rules on the assets it takes as collateral to borrow funds, further unsettling investors.

“Although the SLS has a finite life, we expect the Bank will announce a new facility using similar principles,” said Paul Measday, analyst at JP Morgan Cazenove.

“We believe it makes sense to maintain a scheme that has successfully provided liquidity to the banking system whilst funding conditions remain difficult and the future is so uncertain,” he said in a note.

Several other analysts agreed, but said there were jitters about the mechanics.

“There is uncertainty (about) what it will be replaced with... there seems to be a battle going on, with politicians happy to provide support to the mortgage lenders but the Bank more reluctant,” one analyst said.

“The Bank clearly doesn’t want anyone to fail but on the other hand they (banks) have to manage their liquidity risk.”

Politicians are concerned that lenders will pull back even harder on lending if funding becomes more difficult, heaping more pressure on the brittle housing market.

BoE Governor Mervyn King said in June the SLS would be replaced by a liquidity facility that works under both “normal and stressed” market conditions. It will be part of its red book review of open market operations, expected to be unveiled before the SLS window closes.

The new plan is expected to run separately to any government measures introduced as part of James Crosby’s review of the mortgage finance market. That review is expected this month.


King said the liquidity backstop represented “a balancing act, between avoiding a major shock to the system and encouraging future reliance on the same cheap but risky funding sources”.

The SLS was brought in in April to help ease strains on banks and building societies and boost confidence in the financial system by allowing lenders to exchange hard-to-trade mortgage assets for government bills.

The BoE said initial demand for the scheme was likely to be about 50 billion pounds but never set an upper limit. Analysts reckon near 100 billion pounds has been taken, and UBS estimated the amount could top 200 billion.

The Council of Mortgage Lenders this week urged the government to make an early announcement “of the renewal/extension” of the SLS or any other measures being planned to “help to resolve market uncertainty”.

The CML said mortgage funding problems remain a bar to meaningful housing market recovery.

Critics of the scheme say it has allowed banks to bundle up toxic mortgage paper, securitise it and sell the package to itself so it can pledge it to the BoE. (Additional reporting by Christina Fincher and Jane Baird; Editing by Sharon Lindores)

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