BoE launches discount window facility on Monday

The Bank of England will launch on Monday a permanent successor to its Special Liquidity Scheme introduced to ease the credit crunch, in a major reform of the way it keeps money flowing through the financial system.

The central bank said yesterday it would create two new facilities for banks to access funds depending on what it is needed for and that should remove the stigma that has come to be attached to using its present emergency lending facility.

Firstly, there will be a new overnight operational standing facility from Monday where banks short of funds for technical reasons, such as a payments glitch, can borrow funds 25 basis points above the BoE’s main lending rate, down from 100 basis points before.

The BoE will also create a 30-day discount window facility for banks with a more fundamental need for funds.

The charge for this would start at 50 basis points and rise depending on the quality of the collateral declined and usage of the facility.

“These arrangements set out our liquidity provisions in a systematic way to help banks plan their access to central bank liquidity, and so add certainty,” BoE Governor Mervyn King told reporters.

The BoE only reformed its money market operations two years but the credit crisis that started last year has forced central banks around the world to innovate how they provide funds to cash-starved banks which are afraid to lend to each other.

The BoE created a temporary Special Liquidity Scheme in April that allows banks to exchange their illiquid assets for safe government debt.

It was due to expire this month but has been extended to the end of January and will run in tandem to the new discount window facility, though the SLS provides funds for up to three years and is limited to accepting legacy assets.

To avoid a witch hunt over which banks are using the facilities, the BoE will only publish an average use of the standing facility once a month rather than the daily basis it does now.

Average use of the discount window will be published once a quarter.

The BoE said it would also consult on a new bidding process for its money market auctions to help it gauge the need to accept lower quality collateral in exchange for central bank money.

The proposed structure would see banks make separate bids depending on the quality of their collateral. For example, a bank could offer six per cent when it was putting up gilts but seven per cent when offering mortgages.

A large spread between those two bids could indicate a need to allocate more funds to banks offering lower quality collateral.