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16 November 2018 | 12:14AM GMT

Europe Banks

“Brexit disagreement” hits UK bank shares, but systemic risk low

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(1) Money markets: Limited evidence of funding strain in €, US$ or £

Source: Datastream

Exhibit 2: … with no pressure implied by the $/£ cross-currency swap

US$/£ cross-currency swap (3 months), bp

Source: SecDv

An important element guaranteeing stability are the central bank backstops.The Bank of England created a set of facilities at the height of the financial crisis to provide ample liquidity to the UK banking system.The currently available facilities comprise regular market operations (OSF, DWF, ILTR) as well as non-standard measures such as US$ repo, contingent term repo facility and emergency liquidity assistance. Around the Brexit referendum, it has broadened its offering, by (i) increasing the frequency of its ILTR facility (from monthly to weekly) and (ii) launching the term funding scheme, under which banks borrowed over £120bn on a four year term.

In a first reaction to the outcome of the referendum on Britain’s EU membership, BoE governor Mark Carney highlighted that “as a backstop, and to support the functioning of markets, the Bank of England stands ready to provide more than £250 bn of additional funds through its normal facilities”.This figure relates to pre-positioned collateral (net of applicable haircuts) that major banks have with the Bank of England.

So far, the Bank of England has not reiterated this comment; however, we note that in essence the same facilities remain in place and available.

Source: Bank of England

nPurpose: The OSFs have two roles: (i) providing an arbitrage mechanism to prevent money market rates moving far away from the Bank Rate and (ii) providing a means for firms to manage unexpected payment shocks (arising due to technical problems either in their own systems or market-wide infrastructure).

nEligible Participants: Banks, building societies, broker-dealers and central counterparties.

nEligible Collateral: Level A.

nOperation: The operational standing lending facility allows participating institutions to borrow reserves directly from the Bank on a bilateral basis throughout each business day.

nMaturity: The operational standing lending facility is an overnight lending transaction.

nFees: Institutions borrowing from the lending facility are currently required to pay a 25 bp premium over Bank Rate.

nDisclosure: The average daily amount outstanding in the OSFs during each maintenance period (typically 1 month) is published on the third Wednesday of the following maintenance period.

Discount Window Facility (DWF)

nPurpose: The DWF is aimed at institutions experiencing a firm-specific or market-wide shock.

nEligible Participants: Banks, building societies, broker-dealers and central counterparties.

nEligible Collateral: Level A, Level B and Level C (banks, building societies and broker dealers only).

nOperation: The DWF is a bilateral on-demand facility that allows institutions to borrow gilts in return for less liquid collateral in potentially large size and for a variable term, thereby allowing participants to perform a liquidity upgrade of their collateral. Participants can then raise cash by lending the gilts in the market (or by using them as collateral in the ILTR). If government bond repo markets fail to function properly, the Bank may lend (sterling) cash instead of gilts.

nMaturity: 30 days for banks, building societies and broker-dealers, 5 days for central counterparties. All drawings are repayable at any point and participants can apply to roll drawings in order to fulfill longer temporary liquidity needs.

nFees: Fees are fixed for drawings up to 5% of a firm’s eligible liabilities and are dependent on the collateral used: Level A

– 25 bp, Level B – 50 bp, Level C – 75 bp. The average cost of borrowing between 5% and 15% of eligible liabilities rises thereafter.

nDisclosure: DWF usage is disclosed averaged across counterparties and over a calendar quarter. The data is released with a significant lag in order to ensure that any drawing should have ended before data on it are published: data on the

Indexed Long-Term Repo (ILTR)

nPurpose: The Bank’s market-wide ILTR operations are aimed at institutions with a predictable need for liquid assets.

nEligible Participants: Banks, building societies and broker-dealers.

nEligible Collateral: Level A, Level B and Level C.

nOperation: ILTR operations are conducted through an auction process, whereby participants bid for a nominal amount with a spread to Bank Rate against a specific collateral set. There is no restriction on the aggregate value of bids that can be submitted. In terms of the supply of funds, the Bank is able to increase the amount of funds available if the pattern of bids observed in the auction suggests greater demand.

nMaturity: ILTR funds typically have a 6-month maturity.

nFees: ILTR auctions use a ‘uniform price’ format, where every successful bidder pays the ‘clearing spread’ for borrowing against a specific collateral set.

nDisclosure: The Bank publishes the aggregate amount of funds allocated under any ILTR operation later the same day.

US$ Repo Operations

nPurpose: The Bank’s US dollar repo operations were originally introduced in co-ordination with other central banks in September 2008, in order to provide short-term US dollar liquidity at a time of elevated pressures in US dollar short-term funding markets. These operations are facilitated by a reciprocal swap agreement the Bank has with the Federal Reserve.

nEligible Participants: Banks, building societies and broker-dealers.

nEligible Collateral: Level A, Level B and Level C.

nOperation: The Bank announces the rate applicable for any US$ repo operation before inviting bids from participants. There is no maximum bid size and no limit on the amount of US$ repo funding that is provided.

nMaturity: US$ repo operations are for a 1-week fixed term.

nFees: The applicable rate for any US$ repo operation is set by the Bank prior to the operation.

nDisclosure: The Bank publishes the results of US$ repo operations later the same day.

ContingentTerm Repo Facility (CTRF)

nPurpose: The CTRF allows the Bank to provide flexible liquidity in response to actual or prospective market-wide stress of an exceptional nature.

nEligible Participants: Banks, building societies and broker-dealers.

nEligible Collateral: Level A, Level B and Level C.

nOperation: The CTRF uses a similar auction process to the ILTR, with participants bidding for a nominal amount with a spread to Bank Rate.

nMaturity: The precise term(s) of CTRF funds offered is at the discretion of the Bank when it decides to conduct a CTRF operation.

nFees: Again, as in the case of ILTR auctions, the CTRF uses a ‘uniform price’ format, where every successful bidder pays the ‘clearing spread’.

nDisclosure: The Bank publishes the aggregate amount of funds allocated under any CTRF operation later the same day.

Emergency Liquidity Assistance (ELA)

During the 2008 crisis, the Bank of England provided a significant amount of liquidity support covertly to both HBOS and RBS. As pointed out in Ian Plenderleith’s ‘Review of the Bank of England’s provision of Emergency Liquidity Assistance in 2008-09’, the evolution of the bank’s sterling monetary framework (in particular the DWF) means that there is now a much reduced space in which ELA might be needed (however such situations do still exist).

nPurpose: The purpose of ELA is to provide liquidity support for a short period of time to systemic institutions that are judged to be fundamentally solvent and have a credible path to exit from such measures (i.e. repay the ELA).

nEligible Participants: Banks, building societies and broker-dealers that are judged to be systemic, solvent and have a credible path to exit ELA support.

nEligible Collateral: By the nature of ELA support, collateral used is likely to be outside of the standard sets of eligible collateral available for the other operations (in particular the DWF). An example is the use of unsecuritised loans as collateral for ELA in 2008, when they were not accepted for the Bank’s other market operations.

nOperation: The decision as to whether to extend ELA and the manner in which this is done will be ultimately decided by the Bank of England and the Treasury, following bilateral discussions with the institution(s) concerned.

nMaturity: Again this will depend on the precise circumstances of ELA support. In 2008, the sterling ELA facilities had terms of one month, but were renewable on a rolling 14-day basis.

(3) ECB (or €) backstops: Ample funding, full allotment / fixed rate in regular intervals

The financial market tensions that Euro area banks experienced since 2007 called for exceptional actions by the ECB regarding liquidity provisions. Regular market operations (1-week MRO and 3-month LTRO) have been complemented by non-standard monetary policy measures, including 3-year LTRO (now expired), US$ MRO and two series of TLTROS (targeted LTROs) aimed at improving bank lending. Ultimately, national central banks can extend emergency liquidity assistance to solvent financial institutions.

Exhibit 8: ECB regular market operations have been complemented by non-standard policy measures in recent years

Eurosystem open market operations, including marginal rate and allotted amount

TLTRO 2 auctions have ended, maturities until 2021

Source: ECB