Doubts over UK and ECB bank support

As the European Central Bank (ECB) acts to reduce its liquidity support for eurozone banks, UK banks may face dire consequences from heavy use of the Bank of England's support scheme.

From the start of February, the ECB will enforce far more severe haircuts on asset-backed securities (ABS) used as collateral for the bank's lending facility. Previously, haircuts for ABS ranged from 2% to 18%, depending on the maturity and coupon; all will now take a 12% coupon. ABS which are "theoretically valued" will take an additional 4.4% haircut. Unsecured bank bonds will take an additional haircut of 5%.

ECB chairman Jean-Claude Trichet said today: "We want to be sure that the eurosystem remains adequately protected against the changes in the financial markets. We are not changing the system - we are refining it." He added that the move would mean that some banks would need to supply additional collateral before February in order to maintain their current financing levels, but said "I don't think it will impair the ability of banks to use our operation."

The decision was made to control the bank's own risk exposure - any effect on the market would be a "by-product," Trichet said.

The move follows reports that ECB governors felt their liquidity facilities were being abused by banks. Trichet said that "we have observed an increase in the use of unsecured bank bonds" as collateral, and last month ECB governor and Dutch central bank president Nout Wellink told Dutch press that the ECB "cannot continue to provide liquidity to banks with money market problems forever" and said that banks should be encouraged "to tap other sources of funding".

Meanwhile, the Bank of England's Special Liquidity Scheme, created in April this year, is due to expire next month. UBS banking analyst Alastair Ryan warned that the closure could create "an overhang of funding needs" as banks seek to replace the estimated £200 billion they have drawn against mortgage collateral.

Extending the facility would be the best way of avoiding a "catastrophic" reduction in outstandings and house prices, but this has been ruled out by the Bank, Ryan wrote.

See also: Debt issuance rebounded in Q2, reports BIS
Crosby Report wary of more UK government intervention
BoE reveals £50bn liquidity facility
Central banks act again to preserve liquidity