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The possible stigmatisation of UK Treasury Bills

Julian D. A. Wiseman

Abstract: The Bank of England’s Special Liquidity Scheme might cause a slight stigmatisation of UK Treasury Bills.

Contents: The Bank of England’s New facility, UK Treasury Bills, Consequences, A possible improvement.

Publication history: only here. Usual disclaimer and copyright terms apply.

The Bank of England’s new facility

On Monday 21st April 2008 the Bank of England announced a Special Liquidity Scheme (information, market notice). This scheme allows commercial banks to borrow specially created Treasury Bills from the central bank, in return for lending other securities, typically repackaged mortgages and credit cards. The intent is presumably to lubricate the money markets, making it easier for banks to obtain collateral with which they can borrow, whether that borrowing is from the BoE or from other commercial banks.

The Bank has, rightly, specified steep haircuts:

The Bank of England will decide the margin between the value of the Treasury bills borrowed and the value of the assets banks are required to provide as security. For example, if a bank were to provide £100 of AAA-rated UK residential mortgage-backed securities, it would, depending on the specific characteristics of the assets, receive somewhere between £70 and £90 of Treasury Bills. A complete list of margins is included in the market notice.

But the most interesting feature is the price of the facility:

Banks will be required to pay a fee to borrow the Treasury Bills. The fee charged will be the spread between the 3-month London Interbank interest rate (Libor) and the 3-month interest rate for borrowing against the security of government bonds, subject to a floor of 20 basis points.

So a commercial bank unable to borrow at Libor, or unable to borrow enough at Libor, could exchange illiquid assets for T-Bills, and then use the T-Bills as collateral in a repo transaction to borrow from the central bank or other counterparties. So far, so good.

Next consider the position of a bank able to borrow unsecured at Libor in good size. Such a bank, when needing money could:

The former would probably be more expensive, and cannot be less expensive, as the ½%+ of Libor–repo spread would be paid over the whole 1-year life of the transaction, even on days on which the commercial bank is not benefiting from the cheaper funding. So for a bank able to borrow enough at Libor, this facility wouldn’t help.

So the only users of the facility will be those unable to borrow, or unable to borrow enough, at Libor.

A possible improvement

If almost all banks cannot borrow in size at Libor, then most banks might have to use this new facility—thus destigmatising it. But if a few large banks endeavour to be superior by not using it, those only slightly weaker would also have an incentive to avoid delivering T-Bills, possibly pushing the yet weaker into the same position, and leaving as takers only those so weak as to have no choice. Can this problem be repaired?

One possible answer would be to cheapen it: make it cost 20bp + half of the excess of the spread over 20bp (subject to a minimum cost of 20bp). Then, if Libor–repo is +50bp, the overall funding cost when providing this lower-grade collateral would be 15bp cheaper than unsecured borrowing. Hence strong borrowers would use it. Hence using it would not imply weakness. But this may well result in much of the UK banking system’s assets being lent to the BoE: would the Old Lady be willing to become such a central counterparty?

This problem could be lessened but not eliminated by raising the 20bp threshold. But a real solution would not entail adding complexity to a needlessly complex system of intervening in money markets.

UK Treasury Bills

Many market participants might be more accustomed to the US market in T-Bills: that being massively liquid and huge. This is not so in the UK. The outstanding stock of Treasury bills is only ≈£19bn, and the secondary market is very thin. There is not much action. In the primary market bills typical auction near GC–5bp to GC–10bp.


So, if a counterparty, probably for the first time ever, produces some billions of T-Bills as collateral (even if as DBV collateral), what can be concluded? With very high probability these came from the BoE’s new facility. And hence the lender can conclude that the provider of the collateral is unable to borrow, or unable to borrow enough, at Libor. Thus there could be a slight stigmatisation of T-Bill collateral, with gilt collateral not being so stigmatised. And if strong borrowers cease to be willing to post T-Bills as collateral, for fear of being thought weak borrowers, the auction price of T-Bills might soften to nearer GC flat, or even to GC+something. (Of course, the T-Bills could be sold, but any bank selling so many bills would be sending the same signal.)

It is, at least, a testable hypothesis.

— Julian D. A. Wiseman
New York, Monday 21st April 2008

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