How effective is central bank help?
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How effective is central bank help?

A new kind of crunch

When the Bank of England announced on April 21 that it would start accepting AAA- rated mortgage securities as collateral for low interest rate loans, it also estimated that its Special Liquidity Scheme would provide an initial £50 billion in funding to the banking industry. It’s not known at this point how much of that sum has been taken up to date – but it might not stretch very far. Gregg Kohansky, senior director in the European structured finance team with Fitch Ratings in London, says that the agency has already received a large number of rating enquiries from banks wanting to take advantage of the SLS, including a couple of jumbo transactions in which the issuer is seeking to securitize £10 billion in loans in one shot – although haircuts apply to the amounts actually received in SLS funds.

"Some lenders seem to be hoping to finance a larger portion of mortgages in one go via the SLS, whereas in the past they would issue far smaller deals in the hope that RMBS spreads would remain at relatively tight levels and, as a result, they could issue again as and when necessary," Kohansky says.

Bank of England Governor Mervyn King, told the House of Commons Treasury select committee that the SLS had been put in place to shore up the market’s confidence and prevent bank runs. As such, the scope of the scheme is fairly limited: only loans made before the end of 2007 are eligible for the SLS. "The reason the Bank of England did that was to free up liquidity for what was perceived as overhanging collateral – banks had a lot of unsecuritized loans already on their books and were struggling to get financing," says Ronald Thompson, head of securitization research with RBS global banking and markets in London. "What the central bank didn’t want was to encourage a mass of new lending. It’s a fairly conservative approach and other central banks have acted more aggressively."

The European Central Bank’s more liberal approach might backfire. If given the freedom to use newly originated loans as collateral for cheap funding, there’s always the danger that banks might try to take advantage. Fitch’s Kohansky says that eligibility criteria for repo transactions with the European Central Bank have already led some issuers to structure transactions with riskier collateral profiles. A Fitch report published on May 7 notes that the agency, "has observed in some jurisdictions that asset selection criteria have become more aggressive than prior to the market shutdown as banks seek to maximize liquidity from otherwise illiquid assets. The change in profile of collateral offered in terms of lower credit enhancement and riskier assets means that there has been a shift towards more volatile collateral for ECB funding."

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