Bank's £10bn of funding again attracts no bidders

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The Bank of England's liquidity sale drew no bidders for the second week running yesterday, helping to fuel a rally in bank shares. But industry sources warned the lack of take-up could mask continuing funding strains for some smaller lenders, while larger British banks have already taken advantage of cheaper facilities on offer from the European Central Bank.

Britain's central bank offered £10bn of three-month funding at a penalty rate of at least 6.75 per cent in the second of four auctions. It said it planned to press ahead with the rest on the same terms.

The Northern Rock crisis had fuelled fears about other banks that borrowed in the money markets running into trouble as banks hoarded cash to cope with the credit crunch. Investors have viewed the lack of take-up at the auctions as a sign that banks are able to fund themselves.

Sources have said the falling rate for inter-bank borrowing does not mean that the market has returned to normal and that some banks and building societies might still be struggling to fund their businesses in the markets. Banks had hoped that the Bank of England would cut its penalty rate to reduce the "stigma" for any bank caught bidding in the auction.

"There is a feeling abroad that intellectual purity has been put ahead of straightforward market pragmatism," a banker said.

Alliance & Leicester led banking shares up, rising 5.5 per cent, closely followed by HBOS and Bradford & Bingley. Alliance & Leicester's shares fell 31 per cent on one day last month on fears that it would need emergency funding from the Bank of England.

Alliance & Leicester's chief executive, David Bennett, said yesterday that if the bank continued to fund itself in the same way as it had since mid-August it would not need to go to the capital markets again this year. "If we see suitable opportunities, we may take them," he added.

The Bank of England's penalty rate is a percentage point above base rate and almost half a point above three-month sterling Libor, the rate at which banks will lend to each other. The Bank of England has said the falling cost for banks of borrowing from other lenders has made its auctions look expensive.

The Bank yielded on its hard-line stance to the credit crunch by announcing the auctions and accepting a wider range of collateral than it had before. It has sought to avoid the "moral hazard" of rewarding risky behaviour with cheap lending.

But banks have said the freezing up of the markets does not differentiate sufficiently between reckless and prudent lenders for the Bank of England to take such a hard line.