3 Ways the BOE is Delaying More QE

After a close 5-4 vote on increasing its asset purchases last month, it seems that the Bank of England (BOE) blokes are getting creative at addressing calls for action without actually buying more bonds.

Their latest efforts are focused on encouraging U.K. banks to lend to businesses and consumers. Apparently, the banks stocked up on cash in the belief that the euro zone crisis will shut them from their creditors. This limited the banks’ capacity to lend to vital market players like businesses.

Over the past couple of days the central bank has revealed at least three ways it can boost bank lending without directly buying more bonds:

1. Release the ECTR!

Established last December, the BOE’s Extended Collateral Term Repo Facility (ECTR) aims to give cheap cash loans to the U.K.’s banks. The BOE plans to allocate 5 billion GBP worth of six-month loans once a month until further notice. The loans are paid at a rate 25 basis points higher than the BOE’s current cash rate (0.50%).

The BOE tapped the program for the first time last week, auctioning the minimum amount of 5 billion GBP at 0.75%. Since both the loans and interest rates were at their minimum, market players took it as a sign that the banks aren’t in any urgent need for liquidity. Analysts estimate that the program will give banks access to up to 160 billion GBP worth of cheap loans.

2. BOE to post collateral on its derivatives

Last week the BOE announced that it would start posting foreign currency bonds, or bonds that are issued in currencies other than the pound, as collateral to its counterparties in over-the-counter (OTC) derivatives.

UK money tree

First, you should know that a derivative is simply a contract that involves an underlying asset, and tends to be used for hedging. For example, if a British firm expects a delivery of goods in US dollars, it may enter into a derivative contract with another firm to limit the risk of their goods dropping in value due to currency fluctuations.

In a regular derivative contract, both parties post collateral in case one party fails to meet its obligations. But thanks to European laws, central banks are exempted from posting collateral.

Let’s say that the BOE signs a derivative contract with Firm A. Under their agreement, Firm A is required to put up $100 million in collateral should the contract turn in favor of the BOE. But if the opposite happens and Firm A stands to gain from the contract, the BOE isn’t required to post collateral. If the BOE fails to meet the terms of the contract, Firm A will gain nothing.

Among other options, counterparties like Firm A (usually banks) limit their risk by giving the central bank steep deals and charging unfavorable rates to its customers. By agreeing to post collateral, the BOE would be able to get cheaper contracts while removing funding risk for its counterparties at the same time.

Take note that by posting foreign currency bonds, the counterparties won’t be receiving pounds, which will most likely be devalued if the BOE defaults on its obligations. Score another one for the counterparties!

3. Banks to take a chill pill on liquidity requirements

As if giving cheap loans and posting collateral aren’t enough, the Financial Policy Committee (FPC) is also relaxing its rules that require banks to store liquidity buffers like cash and cash equivalents.

Though no exact figure was mentioned, Mervyn King said that the effect of loosening the banks’ purse strings would be significant. And why not? The BOE estimates that 15% of the U.K. banks’ assets are liquid, with as much as 500 billion GBP allotted to the buffer. The Financial Services Authority (FSA) is expected to enact the FPC’s recommendation over the next few weeks.

Unfortunately, these three measures don’t necessarily translate to more bank lending. In fact, some market geeks predict that the banks will use the extra money to pay their debts rather than lending it out.

For now it looks like the BOE members are optimistic, saying that the potential impact of these projects are significant enough for them to consider in this month’s monetary policy meeting. Will these projects be enough to keep them from implementing more QE in July?