Bank offers mortgage backed securities swap

The Bank of England is to allow banks to swap mortgage backed securities – at the nexus of the credit crunch – with over £50 billion worth of government bonds.

Full details of the deal are to be announced in parliament by chancellor Alistair Darling, but the securities will be taken at a discount so the government is not seen to be offering aid.

If a bank provides £100 of AAA-rated UK residential mortgage-backed securities, it will, depending on the specific characteristics of the assets, receive between £70 and £90 of Treasury Bills.

It is thought banks will also be pushed to disclose more losses and turn to shareholders – as RBS is reported to be considering – to raise funds.

Government bonds will have a maturity of up to a year - but can be renewed for a period of up to three years - meaning under existing accounting procedures they will not be considered part of the country's national debt.

A Bank of England statement said: "Banks can, for a period, swap illiquid assets of sufficiently high quality for Treasury Bills. Responsibility for losses on their loans, however, stays with the banks."

"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," Mr Darling told the BBC.

"This is an essential initial step in trying to get the financial market stabilized and that in turn will help the mortgage market. We can reopen the financial markets because that is an essential pre-condition for the provision of mortgages."

Mervyn King, governor of the Bank of England, said: "The Bank of England’s Special Liquidity Scheme is designed to improve the liquidity position of the banking system and raise confidence in financial markets while ensuring that the risk of losses on the loans they have made remains with the banks."

An initiative to help the banking system has been widely anticipated, after banks reportedly told Prime Minister Gordon Brown during a meeting at Downing Street last week that more had to be done to ease the credit crunch.

Banks have already withdrawn several mortgage products from the market and some are ignoring the most recent base rate cut.

The British Bankers' Association (BBA) now claims the action from the government will restore confidence on the money markets - which may eventually trickle through to better mortgage deals for UK borrowers.

A BBA spokesman said: "The banks are participating in this arrangement and expect it to make a significant contribution to alleviating the pressures in the UK money markets.

"Restoring confidence in the wholesale funding market will strengthen the financial system and the stability of our economy."

He added: "The banks will continue to work closely with the government, the central bank and the regulator to keep markets open and remove obstacles to ensuring that credit remains available to businesses and households."

While criticising the length of time for the Bank to take action, the Intermediary Mortgage Lenders Association (IMLA) has also welcomed the move.

"We would have liked action to have been taken more quickly, given the damage that has already been inflicted on the market," said IMLA executive director, Peter Williams.

"However, this move is welcome and should start to ease the logjam in mortgage funding. It is important specialist lenders, along with banks and building societies, with AAA rated mortgage backed assets, will be able to swap them against government securities."

"That does mean that the facility will be relatively restrictive and that lenders with non-prime packaged assets will not be able to tap this source of funding," he added.

Yet, some concerns were articulated by the Council of Mortgage Lenders (CML).

"What the scheme does not do is give all mortgage lenders direct access to the new funds. In particular, it does not include smaller building societies and specialist lenders," said CML director general, Michael Coogan.

"Further details are also awaited on how much of the additional liquidity might be recycled responsibly into mortgage products or pricing, so that lenders can bridge the gap between how much consumers want to borrow and how much funding is available this year."

US Federal Reserve chairman Ben Bernanke announced a similar move to US banks for troubled subprime loans earlier this month alongside measures to allow investment banks to borrow directly from the American central bank.

The inability of US homeowners to meet mortgage payments has led to global concerns as investment banks had created securities tied to these loans that were sold to investors and institutions around the world.

Financial institutions around the world have written off close to $200 billion (£100 billion) as housing investments turned worthless, with the world's biggest investment banks such as Citigroup, Merrill Lynch and UBS reporting quarterly losses in the billions due to the defaults.

Banks have hoarded cash since then in order to deal with their losses leading to a lack of availability of funds in the credit markets.

The relatively higher rate of interest charged on banks' lending to each other is a result of uncertainty in the global markets which the Bank of England is now acting to ease by offering bank's safe capital in exchange for assets of doubtful value.

Earlier this year, the government nationalised mortgage specialist Northern Rock as it struggled to finance itself in the wake of the credit crisis.