Wednesday, June 11, 2008

BoE plans liquidity scheme for troubled banks

(FT) Mervyn King promised on Tuesday to keep liquidity in the banking system flowing “in all seasons” as the Bank of England governor outlined plans to create a permanent facility for troubled banks.

The scheme, to be announced this year, will give troubled institutions an alternative to tapping the Bank’s standing facilities, which have proved ineffective since the credit squeeze because banks were reluctant to be seen to be seeking central bank help.

It will be a permanent successor to the special liquidity scheme (SLS) introduced in April to ease the pressures of mortgage-backed securities stuck on banks’ balance sheets. The scheme reflects how the Bank, like other regulators in Europe and the US, has had to rethink its mechanisms for coping with financial turmoil.

Mr King, who was at a banking conference, berated institutions whose reckless lending would cost people their homes. He said the scheme needed to strike a balance between avoiding a shock to the system and encouraging reliance on risky funding.

“If banks feel they must keep on dancing while the music is playing and that at the end of the party the central bank will make sure everyone gets home safely, then over time the parties will become wilder and wilder,” he said. “That might not matter were the consequences limited to the partygoers. But they are not.

“When the party ends, some innocent bystanders may lose their homes altogether.”

Because of that concern, the Bank is giving no guarantee over the scope of the scheme, or the cost to banks of tapping it – and is unlikely to be any more generous than with the current SLS. Mr King promised to make stability the priority of his second term. He is keen to ensure that the Bank has powers to match its responsibilities when ministers finalise arrangements to deal with failing banks.

In spite of playing down talk of a rift with the Financial Services Authority, Mr King made it clear that he thought a regulator should not take sole responsibility for deciding when a bank had to be taken under the control of a new “resolution authority”.

“No regulator . . . can ever fully insulate itself against the risk of forbearance which might delay a necessary resolution,” he said.

He also argued that commercial banks should make upfront contributions to a fund to guarantee depositors’ money if an institution failed.

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