Q&A: What is the Bank of England doing?

What is the Bank of England doing?

After intense lobbying by the banking industry, the Bank has drawn up a plan that is intended to make it easier for mortgage lenders to raise money.

Why?

The authorities have realised that the credit crunch is having an impact on the mortgage market, where loans are being withdrawn or offered at higher rates despite cuts to the official base rate. It is also affecting the amount of lending to small and large businesses which could exacerbate any slowdown in the economy.

How does the Bank of England scheme work?

Banks would be able to lodge bonds backed by mortgages as security at the Bank. The Bank would then exchange the mortgage bonds for government bonds or bills which the banks can then use in the markets to trade for cash.

Does this mean the Bank of England may end up owning people's homes?

Unlikely. Only in the unlikely event of the mortgage lender going bust would this happen.

What does it mean for my mortgage?

Not much really. Many mortgage lenders have already packaged up home loans into bond issues and this proposed system with the Bank of England will be similar. Lenders, though, will need to know which customers' mortgages are being handed over as collateral.

So what's the geeky detail?

The idea is to keep the risk with the mortgage lenders rather than the taxpayer. This will be done by ensuring the mortgage bonds are not exchanged at face value but at a discount - known in the trade as a haircut. The Bank will only allow mortgage bonds with a high credit rating - AAA - to be lodged as security.

So, if a bank were to provide £100 of AAA-rated mortgage backed securities it would receive between £70 and £90 of treasury bills.

What if the value of the banks' assets fall?

If the bonds are downgraded by the credit rating agencies, they will need to be substituted by better rated bonds.

Doesn't the Bank do something like this already?

This would be a change from the current situation. The Bank of England already accepts some mortgage bonds as collateral . They have to be AAA rated and can only be used for three-month funding rather than shorter-term funds of a week or so.

How much money will be become available to the lenders?

A figure of £50bn will be made available initially but this could be doubled if it fails to rescue the £300bn mortgage market.

Does this mean the credit crunch is over?

Certainly not. The mortgage lenders are privately making it known that the extra funds they get access to will merely allow them to maintain the current reduced level of lending, not return to the situation of a year ago when mortgages were freely available.