Richard Murphy: New Funding Structure for the Bank of England Suggests That the Treasury Thinks the Proverbial Is Going To Hit the Fan

Yves here. One quibble regarding this post: Quite a few economists have pointed out that a central bank can operate just fine with negative equity and it does not have to recapitalize itself. But central bankers, having grown up as bankers, have a strong aversion to it anyhow.

I have to confess that since I saw this post just before I was scheduled to turn and have only had time to skim it and cross post it, I have not looked at the underlying material, much the less thought about it. But it makes sense for the UK to be preparing for a hard, ore worse, crash out Brexit. Murphy’s initial reaction seems sound.

By Richard Murphy. Cross posted from Tax Research UK

Philip Hammond sprung a surprise by announcing a new era in the relationship between the government and the Bank of England last night. The details are here. The Guardian, and many others,  comment on the story in a way that is not apparently related to the documentation published, saying:

The Bank of England will be allowed to provide more than £500bn in lending to the economy without seeking the Treasury’s permission, in a move that reinforces the strength of the UK financial system as Britain prepares to leave the EU.

Announcing the plan at the annual Mansion House dinner for bankers in the City of London on Thursday, Philip Hammond, the chancellor, said the changes would help to improve the resilience of the central bank. It would also help with its “ability to meet its monetary and financial policy objectives in the future”, he said.

Hammond said the government would give the Bank £1.2bn, a sum that would underwrite the £500bn lending pot, but the move would not impact public borrowing because the money would remain in the public sector.

I have scanned all three documents published by the government and Philip Hammond’s speech, and the source for this story is not apparent, so it must have come from an independent briefing.  The new arrangements that the documents refer to are also less than transparent in some respects, and so anything I say here is, I stress, provisional.  Some initial thoughts do, however, emerge.

First,  the supposed aim of these reforms is to make the Bank of England more like a bank. It has an enhanced capital base, can retain more of its profits, and has more operational freedom.  That said, this appears to be a charade almost certainly designed to get around government accounting requirements.  It would seem to me as if the increase in risk that the Bank is meant to bear and the supposed right it has to retain profit within certain boundaries is all an attempt to shift the Bank of England’s operations off the central government balance sheet post-Brexit.  That may just be the cynic at play, but I doubt it.

Second, no bank should be running a £500 billion loan book with any risk within on a capital base of £1.2 billion,  meaning that the chance that this money is going to be released into the productive seems very low indeed. I think the intention is instead to bolster the balance sheets of commercial banks if they suffer significant risk post-Brexit.  No other interpretation appears possible to me.

Third,  there are signs that the Treasury and the Bank of England think that things will be extremely difficult post-Brexit.  There are provisions in the new arrangements for ‘collateral haircuts‘. In other words,  if this new lending is asset-backed,  as is likely, then the Bank is anticipating falls in asset prices.

Fourth, it would seem as if the Bank is being given more opportunity to decide when, and if, quantitative easing will be unwound. The interest rate at which it may consider beginning this process has been reduced from 2% to 1.5%.  In my opinion that suggests it is very unlikely that this will happen any time soon.

Fifth,  the coincidence between £435 billion of QE funding and a new £500 billion lending pot backed by £1.2 billion of new capital suggest to me that the new lending is almost entirely dependent upon realisation of QE bonds now held by the Bank. In other words,  all that is being said is that if there is substantial demand for bonds post Brexit as  the saving community head for safety during the course of an economic crisis then the Bank will be allowed to sell  its bonds held under the QE  programme to meet that demand  and will then be allowed to lend back the proceeds into the commercial banking system to make good the liquidity crisis that would otherwise arise.

I stress, this is a  first reaction to a quite complex set of new measures which superficially, and as reported on all the media, make no sense at all.  Unpacked as I present the above they do, however, have a coherent logic,  albeit that the logic in question very clearly suggests that the Treasury and Bank of England are in practice planning for a hard Brexit and a consequent credit crisis for which they are creating the possibility of emergency liquidity funding for commercial banks.

If I am right then I also offer three other ideas. The first is that the Treasury so lacks confidence in the government that it is outsourcing the saving of the economy. Second, this is dangerous: the Bank will, no doubt,  deliver another emergency package that will favour the City and those who are associated with it.  Thirdly, democracy is imperilled once again.

My summary is you should worry: the Treasury clearly is. And they may be right to do so, even if it looks to me as if they are delivering the wrong solution.

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  1. Jack

    The interesting point about this article to me, is that with all that the UK is apparently NOT doing to prepare for Brexit, the one thing they ARE doing is to make sure the commercial banks are protected. The statement “I think the intention is instead to bolster the balance sheets of commercial banks if they suffer significant risk post-Brexit. No other interpretation appears possible to me” makes that clear.

  2. Mark

    This looks like a domestic liquidity plan. I wonder if they’re also beefing up their external liquidity (swap lines) capacity. They’ll be a bandage, at best, if British banks see all risk and no return in a future fiasco scenario.

  3. The Rev Kev

    I wonder if the UK is also stockpiling a vault full of Euros as well as other currencies. I know that the UK was not dumb enough to sign on for the Euro and kept the pound but if they are expecting serious trouble with liquidity, it may be that they might be laying in a supply of the hard stuff as well.

    1. Synoia

      laying in a supply of the hard stuff as well.

      True. If the Pubs run dry there could be a Revolution!

      M: I’m just off the the pub
      F: There’s no beer.
      M I’ll go to the Tory pub then
      F: They’ve run out too, all of them
      M: I’ll go and join the Revolution!!!!!!
      F: Off you go. Try to be back before 11.

  4. paul

    It is extremely hard to argue with richard murphy’s reasoning here.
    The deadbeats nominally in charge are feeling their shorts filling.
    The technocratic solution offered will have enormous appeal to them.
    It will be as well administered as everything else they have attempted

  5. djrichard

    another emergency package that will favour the City and those who are associated with it

    An unfortunate byproduct of central banks. Because really the aim is to simply prevent their naked shorting operation from going in reverse: i.e. deflation. If the benefits of QE primarily accrue to those holding assets, well c’est la vie. If only there was another way …

      1. Skip Intro

        And it is so damned hard to fine good tumbrels these days… crapification y’know.

  6. Mirdif

    I don’t know much about this type of stuff (or about most other stuff as it happens) but is the following plausible: this is in anticipation of a collapse in the housing market coupled with an increase in unemployment leading to people unable to meet mortgage payments so government allows mortgage payment holidays and the like to prevent repossessions en masse? Or perhaps repossessions take place but this lending will support bank balance sheets while the owed monies will be recovered in the longer term>

    Or are there regulations against this type of thing, or are the sums in question (£500 Bn) not enough to support banks in the type of crises I have outlined above? Or am I totally barking up the wrong tree?

  7. Tedwa

    Hammond said the government would give the Bank £1.2bn, a sum that would underwrite the £500bn lending pot, but the move would not impact public borrowing because the money would remain in the public sector.

    Shouldn’t that be 1.2 trillion?
    “but the move would not impact public borrowing because the money would remain in the public sector”?? What the heck does this mean? In the public sector – in the banks private hands?

  8. The Heretic

    The central bank prints the currency of the nation… hence it can never run out of money, nor need an equity base to make loans in its own currency. Why do the bankers of England need this fiction, unless it is to camoflauge its true power.

    1. beachcomber

      @The Heretic

      I think you may be overlooking the fact (for which oversight you can scarcely be blamed) that our esteemed Chancellor of the Exchequer, custodian of our nation’s treasury, hasn’t yet assimilated that piece of information. He seems to believe that the year is 1850, his name is William Ewart Gladstone and his prime duty is to balance the books by means of careful housekeeping. I can readily picture him (his name is actually Philip Hammond) writing his memoranda with a quill pen.

  9. Oregoncharles

    “a hard Brexit and a consequent credit crisis for which they are creating the possibility of emergency liquidity funding for commercial banks.”

    Wouldn’t it be irresponsible not to? At best, which is unlikely, there would be significant disruption.

    This also echoes the EU’s warning to its member states to prepare for a crashout. It’s important to be prepared, whether or not you think it’s destined.

  10. templar555510

    This is yet another attempt to show to an unwitting public that their central bank still has relevance in managing the economy. No serious person believes in the fiction of the independent Bank of England . Mark Carney the present Governor another Goldman Sachs alumni is the bankers’ banker . This nonsense being peddled by Hammond the Chancellor is, as Richard Murphy intimates an oafish let’s do it to them before they do it to us
    crusade to shore up the status quo before the s..t hits the fan ( if it does ) ; aka protect the banks at all costs and damn everyone else.

  11. marku52

    Except that it looks very much like we are getting ready to bail out the TBTF banks (again!)

    “And Joe and Jane Average, you can just go family-blog yourself”

    In the immoral words of Edmund Blackadder
    “There was just one tiny problem with the plan–It was Bollocks”

  12. Mael Colium

    Too many conspiracy theories for my money…….. excuse me!

    The BOE is fiddling around in the political mud box. I’s a bank bail out, but by “loans” in advance it avoids the Government of the day wearing the shite when Brexit blow back reaches mach3. And it’s invisible! Where did the money come from? It’s funny how political expediency suddenly utilises the sovereign’s capacity to issue without selling bonds. Would have been handy during the GFC.

    This is neoliberal arse covering. The elites can’t have the plebs realising that a currency issuing sovereign holds all the cards when they’ve been banging on for forty years about balanced budgets. We should teach macroeconomic sectoral balance principles in school as part of algebra and avoid having to swallow this nonsense.

  13. RBHoughton

    I think of central bankers these days as representatives of the commercial banks. They may be the gatekeepers for international trade but whatever they do is for the benefit of the high street and investment banks. They seems to be of no use to the population at large. We should get rid of them.

    When I read of the frolics that central bank staff did in several Asian countries – Thailand, Korea, Indonesia – it looks as though each central bank acts as an offshore branch of the Fed, no longer under the rule of its national government.

    No wonder globalisation has caused treason to be downgraded. Is it still an offense? In UK the traitor was loathed for centuries. Fearful punishments were awarded …. but not any longer.

  14. notme

    To me it sounds like a system designed to turn Quantitative Easing into Qualitative Easing. What do I mean by that? Well, because the scheme will allow BoE, in effect, to sell the UK/GB Govt bonds that it bought as part of QE, and then turn around and buy lower-QUALITY (hence the term QUALITATIVE easing) private-sector bonds instead.

    If BoE works similar to the FRB, that is, it buys bonds by issuing reserves against them to the selling member bank, the net result will be that GB pound will now be backed (in part, but fungibly so) by higher-risk private bonds whereas at the moment it is backed by lower-risk government bonds. Voila!

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