UK central bank to join battle on liquidity

Financial Times ^ | 3/26/08 | Chris Giles and Krishna Guha

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The Bank of England is poised to take revolutionary action to find a “resolution” to the problems faced by British banks unable to sell or refinance portfolios of mortgage-backed debt, Mervyn King, the governor, signalled on Wednesday.

Mr King also suggested that the Bank was becoming more open to interest rate cuts. His comments came as Hank Paulson, US Treasury secretary, offered strong support for the Federal Reserve’s handling of the Bear Stearns crisis.

Mr Paulson said it would be necessary to examine the regulatory implications of providing emergency finance to investment banks, but stopped short of calling for permanent regulation of investment banks by the Fed.

He emphasised that investment banks’ access to Fed cash was temporary and that big differences remained between these institutions and deposit-taking commercial banks.

In a statement to the British parliament, Mr King said the Bank of England’s existing lending against mortgage-backed securities was “a useful bridge to a longer-term solution”, but can “be only a temporary measure”.

He said a longer-term resolution was needed to deal with the “fragility” of financial markets and to relieve the “overhang on banks’ balance sheets of assets in which markets have closed”.

Mr King was not specific about the mechanisms that might be used. But possibilities are understood to include the purchase or the swapping of asset-backed securities for liquid assets or cash – ideas that have been discussed with other central banks, as the FT reported last week.

To ensure taxpayers were not left with banks’ bad debts, Mr King insisted that the government would have to be insured against any credit losses. Insisting that the big problem in the UK was liquidity, not irresponsible lending, he added: “The banks neither need nor want the taxpayer to insure them against these losses.”

The price banks would have to pay, Mr King said, was tighter regulation and supervision.

Mr Paulson, meanwhile, said the Federal Reserve should bolster its supervision of investment banks while they enjoy access to emergency cash.

But he made it clear that he believed that investment banks merit different regulatory treatment than commercial banks because they do not have taxpayer-insured deposits.

Meanwhile, Jean-Claude Trichet, European Central Bank president, told the European parliament that the ECB was committed to easing financial market tensions, but the rescue of banks facing solvency difficulties would be “in a different universe” and require taxpayers’ money.