Bank of England rescuing banks suffering liquidity

The Bank of England (BoE) has offered £4.4 billion to relieve the banks that are suffering from the current liquidity crisis. The bank issued an operational note and announced a considerable relaxation of the rules governing the way it lends short-term funds to banks.

In addition to honouring requests for £17.6 billion over the next few weeks, it will also provide an extra 25% at a non-penal rate if required. The bank added that the increase should help to ease the pressure on interest rates for overnight borrowing which have, recently, been unusually high in relation to Bank Rate.

London’s Cheyne Capital has announced that one of its Structured Investment Vehicles (SIV), Capital Finance, has been placed into receivership. The £3.27 billion SIV, which has been invested in securitised property deals, has been struggling to stay afloat since sustaining huge loses.

A liquidity famine among banks is rife at the moment following the crisis triggered by the US sub-prime mortgage disaster. The 3-month interbank interest rate, Libor, has risen to nearly 6.8%, more than a percentage point above the 5.75% base rate.

BoE commented that the new measures were not planned, nor could be expected, to narrow this gap. The basis of these problems does not lie in a shortage of central bank liquidity.

BoE concluded that the problem lies in the difficulty of valuing a variety of asset-backed instruments, a reference hundreds of billions of dollars worth of mortgage-backed securities and related derivatives, whose value may have been damaged by the sub-prime setback.

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