Bank of England to Detail Swap Plan for Easing Credit

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By Mark Deen and Jennifer Ryan

The Bank of England tomorrow will release its plan to swap government bonds for mortgage-backed securities in an effort to ease credit costs and help British homeowners, Chancellor of the Exchequer Alistair Darling said.

This will ``unfreeze the situation we've got at the moment,'' Darling said today in a BBC television interview. ``What the Bank of England will do is in effect lend the banks that money. In the meantime, the Bank of England will take a security,'' he said.

Prime Minister Gordon Brown's government is looking for ways to promote lending after an increase in borrowing costs caused banks from HBOS Plc to Lloyds TSB Group Plc to curb credit. That raised the cost of mortgage loans, even after central bank policy makers cut the benchmark lending rate three times since December to help avert a U.K. recession.

By offering commercial lenders government bonds, the central bank will add to their inventory of liquid assets and make it easier for them to both raise cash and lend, especially to consumers seeking mortgages. In return, the government will hold riskier mortgage-backed assets as security.

The central bank and the Treasury may offer a swap of 50 billion pounds ($100 billion), the British Broadcasting Corp. reported yesterday. Former Bank of England policy maker Willem Buiter said that may not be enough. The authorities may need to provide double that amount to kick-start the mortgage market, he said in an interview.

Stabilizing Markets

A Bank of England spokesman declined to comment on Darling's remarks when contacted today by Bloomberg News.

The plan's success ``all depends on the scale,'' Buiter, a London School of Economics professor, said on April 18. ``If they do 5 billion it's not going to do much. If they do 55 billion it would help deal with the overhang of illiquid mortgage-backed securities that mortgage lenders have on their balance sheet and prevent them from engaging in any new lending.''

``This is an essential initial step in trying to get the financial market stabilized and that in turn will help the mortgage market,'' Darling said today. ``We can re-open the financial markets, because that is an essential pre-condition for the provision of mortgages.''

The U.S. Federal Reserve last month made up to $200 billion available to banks in return for debt including mortgage-backed securities and in December created a lending vehicle to make credit available to banks as an alternative to borrowing at its discount rate, which may carry a stigma.

Collateral Requirements

To date, the Bank of England widened its collateral requirements just for three-month lending. It only accepts top- rated government securities at its weekly auctions. It has already cut interest rates three times since credit markets seized up in August as it tries to shore up growth. Economists expect two more reductions by the end of the year, according to the median of 41 estimates in a Bloomberg News survey.

If successful, ``the liquidity support facility may help relieve at least some pressure on the Monetary Policy Committee to cut rates,'' said Nick Bate, an economist at Merrill Lynch & Co. in London.

Darling, who didn't specify the size of the swap program in the interview, said he wants British banks to be as transparent as possible in declaring losses on bad loans. He also urged them to pass on interest rate cuts to consumers.

Rebuild Capital

``It's important the banks begin now to expose the extent of their losses and explain now how they are going to rebuild their capital,'' he said.

Royal Bank of Scotland Group Plc, the U.K.'s second-biggest lender, is considering a share sale to shore up capital depleted by credit-related writedowns and its part in the acquisition of ABN Amro Holding NV last year, according to a person with knowledge of the plan.

``I would like to see banks do more to pass on the interest rate cuts,'' Darling said.

At the same time, the finance minister urged patience, saying the credit crunch partly needs time to work itself out. Darling said one analogy was to someone with a dose of food poisoning, which ``just has to work its way through the system.''

``We can help the process and the Bank of England's measures tomorrow will help the process, which in turn will help the housing market,'' he said.

The Bank of England's most recent reduction in the cost of borrowing was on April 10, when it cut its benchmark interest rate by a quarter point to 5 percent.

The gap between borrowing pounds for three months and the benchmark rate still reached a 3-month high of 93 basis points on April 14. On April 17, financial institutions bid for 50 billion pounds in the bank's weekly auction, the most since January and triple the amount on offer.