These funds will be auctioned off next week, in an attempt to bring three-month inter-bank interest rates down – even though the Bank previously stated that it was not its job to lower three-month rates.
Those eligible to participate in the auction are reserve banks and banks with access to the Banks standing facilities.
The interest rate will be a floating rate expressed as a spread over Bank Rate prevailing over the term of the auction. The rate paid will be as bid by participants, subject to a minimum rate set at the Banks standing lending facility rate.
The additional funds injected in the first auction will be accommodated by widening the range around reserves targets within which reserves are remunerated. This will help to ensure that the secured overnight rate is in line with the Bank Rate set by the Monetary Policy Committee.
British Bankers Association chief executive, Angela Knight CBE, said: “The BBA welcomes the more flexible approach to the provision of liquidity to the Sterling market announced today by the Bank of England.
“The Bank’s willingness to lend for longer maturities than just overnight, against a wider range of collateral, should considerably ease the very tight conditions that we have been seeing in the money market over recent weeks.
“This response, which follows earlier similar measures by the European Central Bank and Federal Reserve, will contribute towards increased confidence after the extreme events of the past few days. However, in the UK there are still concerns about the 100 basis point penalty paid by users of the standing facility.”
Another key feature of this move on the part of the BoE is that banks will be allowed to use a wider range of assets than usual as collateral, including mortgage debt.
Following the excessive increases in the London Interbank Offered Rate (LIBOR) over the past few weeks which have seen it climb above both the Base Rate and the emergency lending rate of 6.75 per cent – however it dropped overnight on Wednesday in response to the cut in US Federal rates.
The Council of Mortgage Lenders (CML) has welcomed the decision. Michael Coogan, director general, said: "This support should enable 3-month funding costs to reduce and get back to more normal levels. This is good news for lenders and for their customers, particularly those with mortgages linked to LIBOR for whom hefty increases in payments were looming."
Banks have been loathe to lend to other banks as a result of the recent instability within the global markets and thus the problem escalated until it reached a head last Friday with Northern Rock’s announcement.
Ian Kernohan, economist at RLAM, commented: “This represents a U-turn on support for money markets and so when faced with the risk of a collapse in confidence, all talk of moral hazard has gone out the window. As every parent knows, it’s all very well to talk tough, but if you don’t follow up your credibility is damaged.”
