Bank of England to make it easier for banks to access additional liquidity when needed

Speaking at an event in London (10-page / 60KB PDF), Mark Carney said that the Bank would begin to offer money for longer periods, at a lower cost and in exchange for a wider range of collateral under its liquidity insurance programme. Carney, who became governor of the central bank in July, said that the new approach showed that the Bank was "open for business".

"Our facilities are not ornamental," he said. "They are there to be used by banks to access money and high-quality collateral."

"Banks can be confident that, when they want to use our facilities, they will be allowed to access them. Because we are both the supervisor and the central bank, the strong presumption is now that, if a bank meets the supervisory threshold conditions to operate and has signed up to our framework, it will be able to use our facilities," he said.

Banks would still be required to properly manage their balance sheets during normal trading conditions, including through compliance with stricter liquidity requirements, Carney said. However, in times of "actual or prospective stressed conditions" the revised framework would "stand ready to provide cheap, plentiful money through more frequent auctions", he said.

On 1 April, the Prudential Regulation Authority (PRA) within the Bank of England took over most of the day-to-day regulation and supervision of banks, building societies and insurers.

Banks and building societies are expected to manage normal day-to-day fluctuations in their available liquid assets themselves. However, because their role involves making long-term loans funded through on-demand or short-term deposits, they operate with a certain amount of 'liquidity risk': the risk that a material part of their funding is withdrawn before assets can be realised at their true economic value.

The Bank of England, through its Sterling Monetary Framework (SMF), is able to support financial stability by acting as a 'backstop' provider of liquidity insurance to UK banks. The SMF is a collection of policies governing the use of the Bank's sterling balance sheet, which also include its asset purchase programme and setting of the central interest rate. Banks have access to three facilities through which to exchange less liquid for more liquid assets: regular, monthly Indexed Long-term Repos (ILTR) auctions; the on-demand Discount Window Facility (DWF); and the market-wide Extended Collateral Term Repo (ECTR) Facility.

In 2012, the Bank commissioned Bill Winters of asset management company Renshaw Bay to look at how the SMF was working in practice, following various changes made in response to the economic crisis. In his report, Winters concluded that the Bank had overall been responsive to changing conditions and that its liquidity insurance facilities had consistently improved both before and after the onset of its economic crisis.

Withers said that although the SMF "functioned properly, was robust, and broadly fit for purpose", the Bank should consider whether even more could be done to improve the usability and flexibility of its facilities and increase banks' confidence in their ability to access them. This was especially relevant given tougher liquidity requirements due to be introduced at a European and international level through the Basel III regulatory framework, he said.

In its response to Withers' report (11-page / 136KB PDF), the Bank addressed the so-called "moral hazard" that by making liquidity insurance more readily available, banks could be induced to take on greater risk. Given its regulatory powers through the PRA to regulate liquidity and, where necessary, wind up collapsed banks and building societies, the SMF no longer had to "shoulder as much of the burden" of managing this as it had in the past, it said. This meant that the Bank could "re-position" its lending facilities, while still encouraging banks to primarily manage liquidity themselves through the private markets, it said.

The Bank also planned to investigate the potential for expanding the SMF to reflect the increasing role of non-banks and capital markets in providing finance to the UK economy, it said in its response. It would provide a fuller response on this next year after further work, it said. It also intends to set out more clearly the circumstances in which it would act as a market maker of last resort, and to examine whether it could provide support in foreign currencies.

In his speech, Carney also indicated that the Bank planned to strengthen its oversight of the so-called 'shadow banking' system, or institutions that provide credit either fully or partially outside of the regular banking system. The Financial Stability Board (FSB), the international watchdog chaired by Carney, has already put forward a set of recommendations to be delivered to the G20 group of leading global economies for action.