THE Bank of England is to swap about 50 billion pounds (UK$100 billion) of government bonds for mortgage-backed securities to lower credit costs and revive lending by United Kingdom banks.
The banks will retain responsibility for losses from the assets they loan to the Bank of England, Bloomberg News said. The swaps will be for one year, renewable for up to three years. Only assets existing at the end of 2007 can be used in the swap.
The measures, backed by the government, mimic a similar swap of US$200 billion of securities by the United States Federal Reserve last month. Policy makers are attempting to encourage lending after a surge in borrowing costs prompted UK institutions to withdraw their best mortgage offers, threatening to exacerbate the worst housing downturn since 1992.
"The Bank of England's Special Liquidity Scheme is designed to improve the liquidity position of the banking system and raise confidence in financial markets while ensuring that the risk of losses on the loans they have made remains with the banks," Bank of England Governor Mervyn King said yesterday.
UK government bonds rose and the pound fell after the announcement, which some economists said leaves the way open for the Bank of England to cut interest rates again to stave off an economic slowdown.
The pound fell to US$1.9890 by 9:48am in London, from US$1.9979 at the end of last week, when it climbed 1.5 percent. Gilts rose, depressing the yield on two-year notes by six basis points to 4.27 percent.
The plan is a change of approach by the Bank of England after three interest-rate cuts since December failed to ease the logjam. The European Central Bank, the first central bank to react to the credit crisis in August, has extended the maturity of money auctions to help cash-strapped institutions.
The swap is double the value of loans King extended in September to prop up Northern Rock. The government nationalized the mortgage lender in February.
It was the first UK bank to fall victim to the credit freeze stemming from the collapse of the US subprime market.
"The collateral swap arrangement is an innovative and unique policy response," the British Bankers Association said. "The banks are participating in this arrangement and expect it to make a significant contribution to alleviating the pressures in the UK money markets. Restoring confidence in the wholesale funding market will strengthen the financial system and the stability of our economy."
The plan will "unfreeze the situation we've got at the moment," Chancellor of the Exchequer Alistair Darling said yesterday.
"What the Bank of England will do is, in effect, lend the banks that money. In the meantime, the Bank of England will take a security."