So long SLS, and thanks for all the liquidity | FT Alphaville

So long SLS, and thanks for all the liquidity

Here’s Paul Fisher waving a curt Bank of England farewell to the Special Liquidity Scheme it started back in 2008.

From a Thursday speech by the Monetary Policy Committee member:

During early 2008, following the collapse of Bear Stearns, and with the continued closure of the securitisation markets making mortgage-backed securities and hence mortgages substantially illiquid, it became clear that additional and exceptional liquidity support would be needed for the UK banking system. The Special Liquidity Scheme [SLS] was designed to provide that support on a one-off basis, in large size and for a long maturity. The form of the Scheme was an asset swap (effectively a collateral upgrade). For a fee, the commercial banks were lent nine-month Treasury bills against a broad set of eligible collateral. In practice the collateral received in the Scheme was dominated by own-name residential mortgage backed securities (RMBS and covered bonds). The banks could use the Treasury bills to raise liquidity in the market, at a time when the primary, secondary and repo markets for RMBS were all closed. These bills were also eligible in the Bank’s repo operations.

The Scheme was limited to lending against collateral that was held on balance sheet at the end of 2007. The principle was that the Bank shouldn’t support the banks in issuing new securities for which there might not be a private market or to subsidise new lending. The fact that the Special Liquidity Scheme was a form of asset swap meant that it had no impact on the supply of central bank money and thus no direct implications for monetary policy. Following standard accounting practice, it was not on the Bank’s balance sheet.

The Scheme will expire at the end of January 2012. It will not be extended or replaced. After three years of large-scale liquidity support the Bank expects each institution to be in a position to fund itself through normal market mechanisms. In order to prevent a refinancing ‘cliff’ at the end of 2011, the Bank has had bilateral discussions with the main users of the Scheme to ensure that there are credible funding plans in place to reduce their use of it in a smooth fashion. Of the £185bn of Treasury bills initially advanced, some £57bn has already been repaid.

You can see some of that refinancing cliff over here, in an old Nomura chart. Worries over the change have led some to call for extension of the scheme. The Bank of England, however, will probably be relieved to see the back of the programme.

In addition to leaving the Old Lady open to criticism for propping up zombie banks, the scheme saw plenty of financial institutions creating so-called ‘phantom securities,’ stuffed with illiquid securities, specifically for the scheme. That created a lot of extra work for the BoE, but also appears to have shifted some extra risk to the Bank’s portfolio.

So long then, SLS.

Related links:
UK banks’ funding fun has just begun – FT Alphaville
Phantom securities which haunt the BoE, quantified – FT Alphaville
The Bank of England, building societies, and the SLS – FT Alphaville