The Bank of England secretly lent huge sums to prop up broken banks. But who cares?by Mark Hannam / December 16, 2009 / Leave a comment
It was, said one MP, “a shocking cover-up.” Another was “outraged”; a third complained about “how many jobs you could support with all this money.” The broadsheets prominently covered the scandal. The cause of the distress? The announcement on 24th November that, in autumn 2008, the Bank of England provided emergency liquidity assistance (ELA) to the Royal Bank of Scotland (RBS) and Halifax Bank of Scotland (HBOS). These “secret loans” totalled about £60bn and were repaid by RBS in December 2008 and HBOS in January 2009.
Those acquainted with the workings of London’s wholesale money markets were unsurprised by the announcement. It was widely known that the Bank of England had provided significant liquidity to banks that were unable to fund themselves, until things got better. And it wasn’t especially hard to guess the likely recipients of the Bank’s help. At most, for the insiders, the Bank had filled in the details.
The idea behind ELA is that a central bank provides temporary breathing space by funding a struggling bank’s operations, allowing it to fix up its balance sheet. This funding is secured by the bank pledging collateral back to the central bank, the value of which exceeds the amount of the loan. Following the Northern Rock débâcle, when support for the ailing bank was unveiled by the BBC in a blaze of publicity, laws were changed to allow for ELA provision without public disclosure. This allowed the central bank to be a secret “lender of last resort,” keeping the borrower’s temporary distress under wraps. It is a perfectly sensible system, and clearly one that worked well in this case.
ELA is neither a subsidy, nor a bailout, nor a public investment. By being made to put up collateral to the Bank of England (of around 1.65 times the value of the loan), both RBS and HBOS actually saw their balance sheets weaken further. Both banks had to pay a big fee to the Bank as well.
The idea that central banks should lend to solvent but illiquid banks, but do so at a penalty rate, is as old as Lombard Street (1873), Walter Bagehot’s classic account of the London money markets. Bagehot’s principle is as valid today: solvent banks should not be allowed to fail without some opportunity to refinance themselves, but they should pay a high price for it.
The Bank of England has,…