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Bank of England to introduce new liquidity facility for all seasons

Bank of England governor Mervyn King has announced it will be putting in place a liquidity facility that works in all seasons, not just under stressed conditions.

Speaking at the British Bankers’ Association’s annual conference, King said the liquidity facility will be part of a set of reforms to its Red Book which will be announced later this year.

He said: “Any such facility will need to meet two challenges: it will need the right pricing structure and it will need to overcome the stigma’ problem that has affected access to all central banks during the current crisis.

King said the pricing structure will be key to striking the right balance.

“It should vary according to the type of collateral which banks provide, as indeed it does to some extent now. Access to central bank money or asset swaps should, as far as possible, encourage banks to manage liquidity risk prudently. Without the correct pricing structure, the incentives to encourage future risk taking are obvious and potentially large. “

King said that valuation margins, or better known as haircuts, are used to protect the Bank of England’s balance sheet.

“By themselves, they aren’t sufficient to create a general pricing structure. The cost imposed by a margin depends primarily on the difference between the costs of secured and unsecured funding, and that will vary across banks and over time. So the key is in the interest rates charged by the central bank.”

King added: “These are challenges that all major central banks are grappling with. They will not be easy to overcome. But with our international colleagues we are aiming to devise a framework that does so. The prize will be an integrated framework, covering all our lending to the banking system and one that I hope, by making clear the terms on which liquidity will be provided in times of stress, will focus the minds of banks long before those stresses emerge.”

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