WHO, WHAT, WHY?

The Magazine answers...



The bank is the UK's central bank

The Bank of England is doing it and it's not the only one. So is the US Federal Reserve, the European Central Bank (ECB), the Swiss National Bank and the Bank of Canada.

In total £54bn ($110bn) will be made available to world money markets by the five central banks, with £10bn up for grabs in the UK. The ECB has made £250bn available ($500bn).

It's known as an auction of funds and it's the first time the banks have joined forces in such a way. But what is the auction all about?

THE ANSWER When central banks offer cash loans to help banks deal with a credit crisis

An auction of funds is when the world's central banks offer cash loans to help banks deal with a credit crisis. It's supposed to ease the strain on the system and help business to continue as usual.

Banks normally borrow from each other or borrow funds from the money markets when they have a mismatch between borrowers and cash. But the money can dry up if some banks start to hoard cash to guard against uncertainty in the world's financial markets.

Stigma

Institutions are currently nervous about lending money because of heavy losses linked to problems in the US mortgage market. No one knows how big the losses are so banks want to hoard money against future losses, and they also fear lending to their competitors who may also be holding big, undisclosed losses.

As a result banks are unable to borrow in the money markets or elsewhere at a cheap rate of interest. It also means that any cuts in interest rates made by central banks are not passed on to individuals and companies.

Other central banks are offering funds

Banks with high loan-to-deposit ratios, such as Northern Rock, have been hardest hit, as they rely heavily on money market funding which has now dried up.

Offering to inject the cash into money markets by auction is an attempt by the Bank of England to reduce the interest rates banks are charging each other and encourage them to start lending to each other more readily.

"One of the Bank's two core purposes is to maintain the stability of the financial system," says a Bank spokesperson. "It has to make sure the overall system is safe and secure and that threats to financial stability are detected and reduced."

BBC business editor Robert Peston says just the announcement of the auction has injected a bit more confidence in markets, but it is limited.

Untouched

"By way of evidence, the interest rates at which bankers are prepared to lend to each other have come down," he says. They fell from 6.627% to 6.514%.

The money on offer does not exist before the auction. It's created for the purpose of lending it out to banks and electronically transfers to their accounts. When the banks pay it back it is usually worked into the bank's accounts but can just disappear again.

WHO, WHAT, WHY? A regular part of the BBC News Magazine, Who, What, Why? aims to answer some of the questions behind the headlines

The amount of money up for grabs is announced before an auction and at what rate it must be repaid and over what period. The £10bn on offer in the UK today will have a three-month repayment period.

Banks then bid for as much as they like of the total available. They put in a bid saying how much of it they want and what interest rate they are prepared to pay above the minimum rate set by the bank. The Bank then allocates the money to the highest until it has run out.

In this case, the Bank had bids for the whole £10bn. It allocated 75% of the money at the low interest rate of 5.39% and the rest at higher rates.

There is always chance that the money could be left untouched. It can be an expensive way of borrowing and there is also a stigma attached to drawing on such funding, as it shows a bank needs to get hold of extra funds.

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