The Bank of England today launched a scheme to allow banks to temporarily swap their high quality MBS and other securities for U.K. Treasury Bills. It said that the overhang of these assets has stretched the financial position of banks. Consequently, this made them more reluctant to make new loans even to each other.
Under the scheme, banks can swap illiquid assets of sufficiently high quality for Treasury Bills. Responsibility for losses on their loans, however, stays with the banks.
“The Bank of England’s Special Liquidity Scheme is designed to improve the liquidity position of the banking system and raise confidence in financial markets while ensuring that the risk of losses on the loans they have made remains with the banks,” said Mervyn King, governor of the Bank of England.
Banks will be able to enter into new long-term asset swaps at any point during a six-month window beginning today. Each swap will be for a period of one year and might be renewed for a total of up to three years. After that, the scheme will close. During the lifetime of an asset swap, banks will be required to pay a fee based on the three-month London interbank interest rate (Libor). The debt management office will supply the Bank of England with the necessary Treasury Bills. Banks will be able to swap for those Bills a range of high-quality assets, including trple-A-rated securities backed by U.K. and European residential mortgages.
Eligible securities must have been held on balance sheet at end December 2007 or be backed by loans held on balance sheet at this date. "This seems to effectively prevent any institution not able to access Bank of England facilities directly, accessing this facility via other banks," Royal Bank of Scotland analysts said. "For master trusts where collateral may include loans originated after this date, 100% of the value of the securities/loans at the end of December will be eligible for the first year, falling to two-thirds in year two, and one-third in year three."
Usage of the scheme will depend on market conditions, but the Bank of England said that discussions with banks suggest that use of the scheme is initially likely to be around £50 billion ($99.3 billion).

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