Friday, 29 May 2009

Tucking in

Bank of England’s Deputy Governor Paul Tucker gave a speech yesterday which FT alphaville picked up. He is surprised by something that doesn't shock me in the least: would be good if regulators, internationally, required all banks regularly to turn over a meaningful share of their ’stock liquidity’ in the market on a reasonably regular basis. That would also help to put banks in a position to reap the benefits of the Bank’s Discount Window Facility, through which, as I have described, sound banks can borrow gilts. Frankly, it has been shocking over the past year or so to discover how many medium-sized banks and building societies did not hold government bonds or other very high quality assets; or, if they did, how many did not have a regular presence in the gilt repo market or even had no capacity to repo at all. Turning up in the core secured-funding markets for the first time for years is an absolute give away of distress. All that has to change.
Gilts trade well under Libor. The gilt repo market is sleepy and sometimes not particularly efficient. Is the Deputy Governor really that surprised that that smaller banks choose not to dabble in a market that will likely lose them money, and which has been something of an insider's club? I know the Bank believes that gilts are the cornerstone of the market, but from the late 90s to 2007 it was the Libor market, not the Gilt market, that was by far the most important source of interbank funding for most players. The only way that the Bank is going to change that is by getting FSA to require banks to buy gilts - which is exactly what they are doing.



Blogger Vaudt Varken said...

David, what exactly do you mean by the 'Libor market'? Do you simply mean short term loans against libor plus some spread? I share your comment that it's not very surprising that smaller banks don't do a lot of repoing.

8:37 am  
Blogger David Murphy said...

Vaudt - I meant, broadly, all Libor-based funding, so yes short term loans priced as a spread to Libor, but also Libor-based short term derivatives and securities used for funding.

Note that part of the problem with banks' use of the government bond repo market and the central bank window is that if most of your funding comes from Libor based sources, you end up with large (if not very volatile) swap spread exposure.

9:20 am  

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