By Ben Livesey
Sept. 3 (Bloomberg) -- U.K. banks probably have tapped the Bank of England for more than 200 billion pounds ($354 billion) less than two months before its emergency funding plan is scheduled to end, according to UBS AG analysts.
The central bank's so-called special liquidity scheme, established in April and set to close in October, allows banks to swap mortgage-backed securities hurt by the credit squeeze for government bonds. Banks may face insolvency unless central bank Governor Mervyn King succeeds with his plan to put in place a new money-market system, UBS said.
``A permanent solution is needed,'' said the London-based analysts led by Alastair Ryan in a research note to clients dated Sept. 1. Otherwise ``U.K. banks will have perhaps 200 billion pounds of exploding funding'' to refinance within the next three years and would be forced to cut back lending and shrink assets. House prices could decline 40 percent without central bank help, Ryan said.
HBOS Plc, Britain's No. 1 mortgage lender, may be the biggest user of the U.K. central bank's bond plan, ahead of Lloyds TSB Group Plc, Barclays Plc and Royal Bank of Scotland Group Plc., Collins Stewart analysts led by Alex Potter in London wrote in a note to clients. HBOS relied on money markets to fund more than 50 percent of new mortgage lending before credit markets seized.
``We're not commenting on speculation about the usage of the scheme,'' a central bank official who declined to be identified in line with bank practice said in a telephone interview today. ``As has always been the case, there's no cap on the scheme. The size reflects its use.''
The U.K.'s Daily Telegraph newspaper reported the estimate of central bank funds used earlier today.
Revive Housing
As the collapse of subprime mortgages in the U.S. deterred bond investors from buying mortgage-backed securities, the Bank of England set up the bond plan as an emergency measure to help U.K. banks fund their mortgage lending. Alliance & Leicester Plc and HBOS are among banks that have cut back home loans, triggering the biggest slump in the British housing market in 30 years.
Prime Minister Gordon Brown suspended a tax on buying some homes yesterday and brought forward 1 billion pounds of spending in an effort to revive the worst U.K. economic slump in almost two decades.
The central bank's swap plan allows banks to exchange securities for low-risk, one-year bonds which can be refinanced every year over the next three years.
`Subsidy'
``The Bank of England have probably gone further than any other bank has gone in that they are offering three-year money at three-month rates,'' Leigh Goodwin, an analyst at Fox-Pitt, Kelton Ltd. in London, said in July. ``That is a subsidy by any other name,'' he said.
U.K. lenders have a 285 billion-pound ``funding gap,'' the difference between lending commitments and current funding from retail deposit and wholesale funding, Collins Stewart analysts said. Still, the amount swapped under the Bank of England's bond plan is ``unlikely'' to be at that level as banks have also borrowed from the European central bank, Potter said.
Trust among banks remains low even after efforts by the U.S. Federal Reserve, the European Central bank and the Swiss National Bank to shore up the world's biggest banks and promote lending.
In response to the continuing turmoil, the Fed said on July 30 it would give securities dealers access to existing loan facilities. It also offers 84-day loans to commercial banks under the Term Auction Facility, known as TAF, in addition to 28-day loans. In total, the Fed has provided almost $1 trillion of emergency loans.
Not Abating
Money markets show that the credit crunch, one year on, is not abating and may be worsening. The difference between what banks charge each other for three-month dollar loans and the overnight indexed swap rate, the Libor-OIS spread that measures the availability of funds in the market, ``remains elevated,'' the Basel, Switzerland-based Bank for International Settlements wrote in its quarterly report.
The spread was 78 basis points today, compared with an average 8 basis points in the 12 months to July 31, 2007, before the credit squeeze started. The strains in global money markets will probably persist ``for some time,'' the BIS said.
Lending between U.K. banks slumped 68 percent to 205 billion pounds in July, compared with a year earlier, as financial institutions hoard cash, the Bank of England said earlier this week, signaling its efforts to revive money markets aren't working.
The Bank of England has provided overnight emergency funding to U.K. banks in the past year as well as several 10 billion-pound portions of three-month emergency loans, in addition to the usual refinancing loans secured on lender's assets.
The ECB lent as much as 304 million euros ($439.5 million) in overnight emergency funding in June, the highest level since December. As of July, the European central bank lent 458 billion euros, mostly short-term and longer-term refinancing loans secured on lenders' assets. Banks can use a wider range of assets to borrow funds from the ECB compared with the Fed and the Bank of England.
To contact the reporter on this story: Ben Livesey in London blivesey@bloomberg.net
Last Updated: September 3, 2008 12:28 EDT
