BOE Urges Banks to Embrace Long-Term Repos Amid Liquidity Concerns

The Bank of England (BOE) urges financial institutions to adapt to a new cash management regime as it reduces excess liquidity in the market. Vicky Saporta, the BOE’s Executive Director for Markets, emphasized the shift from buying assets in exchange for cash-like reserves to lending cash against those assets, a move designed to protect the central bank’s balance sheet from interest-rate risk.

As the BOE continues to decrease its balance sheet through bond sales and not reinvesting maturing gilts, there has been a noticeable shift towards repo operations. However, the central bank now advocates for increased use of long-term operations over the commonly utilized short-term repo (STR) instruments.

Key Points:

Shift to Long-Term Operations

“We need to use other operations to complement the STR,” Saporta stated. “It’s important that firms step up their preparations to ensure they are ready to use them sooner rather than later.”

Declining Excess Reserves

The UK financial system is approaching a point where excess reserves will no longer be available. “It’s important that we and you get ready,” Saporta noted.

Current Liquidity Trends

The demand for liquidity has predominantly focused on the short-term repo facility, which offers one-week repos. Usage has surged to £29 billion ($37.5 billion) from £2 billion at the beginning of the year, compared to just £2.5 billion in six-month loans outstanding.

Participation and Arbitrage Opportunities

Over 60 firms have participated in at least one STR operation, with banks often rolling over their borrowing weekly due to arbitrage opportunities when repo rates rise.

Increased Use of Long-Term Repos

There has been a rise in the use of the BOE’s six-month indexed long-term repo (ILTR) facilities, allowing banks to borrow cash against gilts and lower-rated collateral. The BOE allocated £1.2 billion in an ILTR operation earlier in July, the highest since April 2020, although this borrowing still lags behind STR usage.

Future Outlook

“We are in the process of reviewing the calibration of the ILTR to ensure that it is effective and attractive enough to support potentially large provision of reserves,” Saporta said. “We also expect and would welcome increased usage of the ILTR as we move further into the transition to steady state.”

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For more detailed insights, visit the original article on Bloomberg here.