Scramble for cash as central banks dry up

British banks soon could be scrambling for short-term funding once more amid reports that supplies from Threadneedle Street and from Frankfurt may be drying up.

The Bank of England explicitly ruled out extending its Special Liquidity Scheme (SLS), while the European Central Bank is reportedly considering tightening its lending criteria.

The two central banks have been huge suppliers of liquidity to British banks. The SLS is thought to have provided £50 billion or more, while the ECB has lent banks €467 billion (£378 billion) – much of it thought to have gone to UK institutions.

Despite pressure from some British banks for an extension, the SLS will be closed to new applications from the week of October 20, the Bank said. UK banks have been campaigning for an extension to the scheme, under which the Bank provides banks with highly liquid government bonds in return for illiquid AAA-rated mortgage-backed securities.

As recently as Friday, Rod Kent, the chairman of Bradford & Bingley, called the SLS “a good idea” and contrasted its temporary nature with the permanence of the ECB liquidity window.

The ECB declined to comment on reports that it would change its rules soon, accepting only higher-quality collateral from borrower banks in exchange for cash. At present it accepts securities with credit ratings as low as A-. It also accepts private securities – instruments created by the banks and not traded on any public market. Some ECB officials are concerned that it has become a “dumping ground” for inferior mortgage-backed securities, according to The Wall Street Journal. The reform could come as early as Thursday, when the governing council meets and the ECB makes its monthly interest-rate decision.

While money market conditions have improved modestly in the past few months, banks are still hoarding cash. Three-month sterling Libor has been trading at 5.75 per cent, three quarters of a per cent above base rate, indicating continuing stress in the money markets. Before the crunch the margin was 0.1 or 0.2 of a per cent.

Patrick Hosking
September 2, 2008

Source: The Times

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