The Bank of England's £10bn auction of funds turned out to be a non-event yesterday as no bank took up the offer of three-month liquidity. The news was greeted as positive but the credit crunch continued to play out as lenders tightened corporate lending.
The Bank offered the three-month funding to the market yesterday morning. Banks had half an hour to bid for funds at a rate of at least 6.75 per cent – well above the rate at which banks lend to each other. The three-month London inter-bank offer rate (Libor) dropped to 6.32 per cent yesterday, its lowest since 10 August.
Industry sources said the lack of take-up was good news but that it did not mean no institution was feeling strain. The potential stigma of being identified as the borrower at a penal rate had made it almost inevitable that no one would bid. "Who wants to sit on the naughty chair?" one top-level banker said.
The Bank of England said it would press ahead with further auctions over the next three weeks. Some in the industry said the Bank would need to lower the minimum interest rate to attract bidders. It was also unreasonable to expect big, liquid banks to borrow at uncommercial rates to provide cover for smaller institutions, they said.
The Bank announced the offer of three-month money last week in a move widely seen as a deviation by Mervyn King, the central bank's governor, from his hard-line stance on providing liquidity to the market. Mr King said last week the pricing of the auction balanced a desire to make funds available with the need not to reward risky behaviour. The Bank showed no signs of relenting on the pricing for future auctions, saying they were "a safety valve" and that the fall in the inter-bank rate had made them more expensive.
The offer of funding was meant to help banks that could not borrow from others in the inter-bank market, which had seized up amid the credit crunch. But with the inter-bank rate falling, there were signs that conditions were easing. Money market funds have started buying asset-backed commercial paper from banks' investment vehicles, freeing banks to start lending to each other instead of hoarding funds to fund the vehicles.
Meanwhile, signs are growing that UK companies, rather than homeowners, are bearing the brunt of the credit crisis. The Bank's first Credit Conditions Survey, published yesterday, reviewed the money markets between 21 May and 14 June and then 20 August and 13 September respectively. Thus the data covered the initial phases of the credit crunch, but the survey just misses the Bank's rescue of Northern Rock. This also means that the decline in Libor rates seen over the past two weeks are not reflected in the answers.
Surprisingly, UK lenders told the Bank that, despite the recent turbulence in the markets, the availability of secured lending to UK households – largely mortgages on residential real estate – was unchanged over the period, and expectations were that the supply of mortgages would also remain little changed over the next quarter. One factor seems to be a further intensification of competition within the mortgage market; what effect the decline in business at Northern Rock, recently responsible for 16 per cent of new mortgages, will have remains to be seen. Buy-to-let demand in particular seems to have held up.
Default levels were lower than anticipated and only a modest rise was expected in the next few months. However, availability of unsecured lending – such as credit card facilities – had been tightened up. Instead, the tightening in the credit markets seems to be primarily affecting the corporate sector, including financial companies, with lenders saying that they "expected recent market developments to reduce significantly their capacity to extend corporate credit over the next three months". The majority of respondents expect a further tightening of corporate terms, with lenders imposing stricter covenants, raising collateral requirements and reducing the maximum credit lines.
The tightening of corporate credit reflects the increased cost of funding after the meltdown in the credit markets. Lenders also expect rising defaults by mid-sized companies.
Some thought the Bank's survey over-optimistic about the property market. Malcolm Barr of JP Morgan said: "We have been arguing the mortgage lenders have been insulating UK households from credit market events to a large degree, and that it would take some time for the events of the last couple of weeks to feed through. Right up to the Northern Rock debacle, lenders themselves appear to have agreed."