Wednesday, March 26, 2008

King to consider special help for UK banks

(FT) Mervyn King indicated on Wednesday that the Bank of England was poised to take a revolutionary step and buy or swap illiquid assets on banks’ books for cash or liquid assets as way to find a “longer-term resolution” to the problems faced by British banks.

The Bank governor also indicated the Bank was more predisposed to cutting interest rates now than in February.

Commenting on the “fragility” that exists in the financial system, Mr King said there was an “overhang on banks’ balance sheets of assets in which markets have closed”

“These assets cannot now be sold or used to secure funding in the market – they are difficult to finance. That has created uncertainty about the strength of banks’ financial positions”.

In the short-term, he said the Bank would continue to lend against mortgage-backed securities and other asset-backed securities where markets are closed, but he added that such lending, while “a useful bridge to a longer-term solution” can “be only a temporary measure”.

He was not specific about the longer-term resolution, since he said “it is too soon to say where these discussions will lead”, but he indicated more radical moves were necessary because “it is unrealistic to assume that markets for many asset-backed securities are likely to re-open speedily or, when they do, to their previous levels of activity”.

Mr King’s comments before the Treasury Committee come a week after shares in HBOS, the owner of the Halifax building society and the country’s largest mortgage lender, fell nearly 20 per cent on rumours it had sought emergency funding from the Bank of England.

The Bank of England was forced to deny the rumours and the FSA has launched a criminal investigation into the distribution of the claims. But the share price response shocked senior banking executives and regulators and led to a plea for help for the industry.

The Financial Times reported last week that discussions in central banks around the world include the purchase of mortgage-backed securities or swapping illiquid assets for UK government bonds, a move similar in effect to outright purchase.

But Mr King stressed there were two principles he would insist upon if the Bank was to take illiquid assets off commercial banks’ books to improve their financial positions.

“First,” he said, “the risk of losses on their lending should remain with banks’ shareholders”. This implies the Bank would only accept assets at well below face value, or would insist on banks’ indemnifying taxpayers for the credit risk they would adopt if they took hold of the assets.

“Second,” he added, “a longer-term solution must focus on the overhang of assets and not subsidise issues of new assets”. Mr King is keen not to allow another frenzy of lending and it implies the Bank would not be willing to take any new mortgage-backed securities on its books.

The second condition would be difficult to achieve in full, since improving banks’ finances would improve their ability to lend compared with the extremely strained current conditions. Any action could be perceived as a subsidy, but the Bank governor‘s words indicated he would not be willing to assist banks with new lending.

The governor made it clear that the problems for banks were not confined to the UK. “There is concern in all financial markets around the world that fragility remains today,” he said.

Mr King made it clear that he wanted to separate the financial crisis from monetary policy and said that the two interest rate cuts so far had offset tighter conditions in mortgage markets, so monetary conditions were broadly unchanged.

Asked whether current market conditions made the Monetary Policy Committee more predisposed to a cut in interest rates, he replied: ”Yes”.

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