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Disappointing impact from Special Liquidity Scheme, says Ward

New Star chief economist Simon Ward says UK interbank data is pointing to a disappointing impact from the Bank of England’s Special Liquidity Scheme.

He says figures released by the Bank of England yesterday show that the stock of borrowing from other UK banks, both unsecured and in the form of sale and repurchase agreements, fell by £23m in April and May combined.

The annual growth rate of such borrowing has plunged from 24 per cent to zero over the last year.

Ward says: “The contraction of activity despite the introduction of the SLS may reflect two factors. First, from the demand side, the scheme has probably had little impact on the cost of borrowing for most banks, reflecting its LIBOR-related fee structure combined with large “haircuts” imposed on the value of banks’ securities.”

“Secondly, from the supply side, banks’ unwillingness to lend to each other may be more the result of a shortage of capital and associated pressure to shrink balance sheets than concern about counterparty credit risk, which the SLS seeks to address.”

Ward suggests that capital constraints and continuing interbank funding difficulties are likely to be associated with a further significant slowdown in broad money and credit growth over coming months, increasing the risk of a recession.

He says the prospect of a major lending slowdown is confirmed by figures on unused credit facilities released yesterday.

“Credit expansion has recently been supported by borrowers drawing down existing lines but these are not being replaced by new loans. The stock of unused credit facilities contracted 6.3 per cent in the year to May – the largest annual fall since 1998.”

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