(Bloomberg) -- The Bank of England is urging market participants to prepare for a new cash management regime as excess liquidity is drained from the financial system.
Vicky Saporta, the BOE’s executive director for markets, said the central bank wants to move from buying assets in exchange for cash-like reserves to a system of lending cash against those assets. The move aims to protect its balance sheet from interest-rate risk.
The market has been shifting to repo operations as the BOE reduces its balance sheet through a mixture of bond sales and not reinvesting maturing gilts in its portfolio. But the central bank now wants to see more use of long-term operations as opposed to the short-term repo (STR) instrument that banks have tapped.
“We need to use other operations to complement the STR,” Saporta said. “It’s important that firms step up their preparations to ensure they are ready to use them sooner rather than later.”
Saporta added the point where there will no longer be excess reserves in the UK financial system is “in sight and it’s important that we and you get ready.”
So far, most of banks’ liquidity demand has centered on the short-term repo facility, which offers one-week repos. Usage there has soared to £29 billion ($37.5 billion) from £2 billion at the start of the year. That compares to just £2.5 billion in six-month loans outstanding.
Over 60 firms have participated in at least one STR operation, with banks tending to roll over their borrowing from week to week, Saporta said. It’s attractive due to arbitrage opportunities when repo rates rise.
There has also been some evidence of increased usage of the BOE’s six-month indexed long-term repo facilities, which allows banks to borrow cash in return for both gilts and lower-rated collateral. The BOE allocated £1.2 billion in an ILTR operation earlier in July, the most since April 2020. The borrowing still pales compared to STR usage.
“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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