Lenders borrowed £185bn from BoE scheme

Britain's banks and building societies have borrowed £185bn from the Bank of England – nearly four times the amount that was originally planned – under the Bank's Special Liquidity Scheme (SLS), the central bank revealed yesterday.

The scheme, which closed to new withdrawals on 30 January, was used by 32 banks and societies, accounting for about 80 per cent of the banking market.

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They pledged £287bn of mortgage-backed securities and other hard-to-sell assets in exchange for the Bank's highly liquid Treasury bills. The collateral was worth about £242bn when the scheme ended.

The SLS was introduced last April when the Bank accepted that it needed to do more to restore liquidity to the country's banks. The scheme, viewed as highly innovative at the time, was the Bank's first systematic response to the credit crunch.

The Bank's Governor, Mervyn King, said at the time that he expected the SLS to grow to about £50bn though he left the final amount open-ended. The scale of the take-up shows the strain felt by banks and building societies as the wholesale money markets refused to fund financial institutions.

"Just about everybody has had a go at it," said David Tinsley, an economist at National Australia Bank and a former Bank of England official. "It underlines the need that there has been for a lot of liquidity."

The scheme was introduced following the experience of Northern Rock to stop another bank running out of funding for its loans after the freezing of financial markets made it impossible for lenders to swap assets on their balance sheet for cash. Lenders paid a fee to use the SLS, as well as receiving Treasury bills worth less than the face value of their pledged assets, overcoming the Governor's unwillingness to reward reckless banks and create moral hazard.

The Bank has now replaced the SLS with a broader-based and longer-term "discount window facility" as part of the authorities' range of measures to support the banking system.

The asset swaps made under the SLS will remain in place for three years. The discount window allows banks to swap illiquid assets for government debt for up to a year.

The Bank said that it would continue to make margin calls for extra security if the value of existing collateral, adjusted for the "haircut" discount imposed by the Bank, falls relative to the value of the Treasury bills lent out.

The scheme could not prevent the financial markets losing faith in Halifax Bank of Scotland and Royal Bank of Scotland, both of which nearly collapsed in October as investors refused to fund their risky balance sheets.

The SLS also failed to reduce the cost of credit for retail and corporate borrowers significantly. The continuing credit drought led the Government to introduce further measures last month, including proposals for insuring assets on banks' balance sheets.

"The Special Liquidity Scheme has served its purpose in relation to the overhang of illiquid assets on balance sheets up to the end of 2007," the Bank said. "But financing conditions have remained difficult for banks and building societies and therefore further measures have been introduced by the Bank and HM Treasury."