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Last Updated: Wednesday, 26 September 2007, 12:44 GMT 13:44 UK
Q&A: Bank of England auction
The Bank of England
The Bank of England had promised to lend banks up to 10bn
The Bank of England has held an auction offering to lend 10bn to the UK's banks to ease their credit problems.

It was offering to inject the cash into the money markets in an attempt to reduce the rates of interest that banks are charging each other.

But in the first round of bidding, no banks or building society applied for the cash.

The auction will operate again for the next three weeks.

Is it a surprise that nobody bid for the cash?

Not really. The Bank of England has admitted that, having set a minimum lending rate of 6.75%, the loans were "expensive".

And since the announcement, there has been a significant fall in three-month interbank rates which has exacerbated how costly such a loan would be to a bank.

Analysts have also speculated that banks may have stayed away because of the stigma attached to drawing on the funding.

There was also concern that, although the names of borrowers would not have been announced, the City rumour mill would have eventually unearthed those taking up the loans, highlighting their desperate need to get hold of extra funds.

Why was the Bank of England auction introduced?

Banks normally borrow from each other or gain funds from the money markets when they have a mismatch between borrowers and cash.

However, since August this money has dried up because some banks have been hoarding cash to guard against the uncertainty in the world's financial markets.

This led the Northern Rock to ask the Bank of England for credit, because it was unable to borrow in the money markets or elsewhere at a cheap rate of interest.

Other banks are also having difficulty borrowing money.

It was hoped that this injection of cash would encourage banks to start lending to each other more readily.

This would help to lubricate the money markets and reduce the rates of interest that banks are charging each other.

How is the Bank of England's auction working?

After there were no bidders in the first auction - where up to 10bn was available - the Bank of England will repeat the process every Wednesday for the next three weeks.

The day before each auction, the Bank will say how much is available and at what rate it must be repaid over a three-month period.

UK banks will then be able to 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 - currently 6.75%.

If there are any bids, the Bank then allocates the money to the highest bidders until the money has run out.

A big change is that the Bank of England will now accept a wider variety of bank assets, including mortgages, as collateral.

This change in the rules allows financial institutions to borrow more than they would have done previously.

They can also keep the money for much longer before paying back the Bank of England.

Are mortgages really an asset?

Yes, because they represent a promise by homeowners to pay funds to the Bank in the future.

If the Bank of England did lend out money, where would it be coming from?

The money doesn't exist at present.

The Bank of England creates it for the purpose of lending it out to the banks and electronically transfers it to their accounts.

However, the banks will have to pay it back within three months, when it may simply disappear again.

What is the Bank of England's job?

The Bank of England has two important jobs.

It maintains the stability of the pound and prices in the UK. The Bank has to meet the government's inflation target of 2%.

The Bank of England is also responsible for ensuring financial stability by detecting and reducing threats to the banking system.

In exceptional circumstances, it may act as the lender of last resort if banks get into trouble.

Does the Bank of England normally lend money to banks?

The Bank of England normally has an overnight lending facility available to commercial banks for them to draw on, but it charges a rate above the base rate.

Currently, this is 6.75%, one percentage point more than the Bank of England's base rate, which is relatively expensive.

If banks borrow from the Bank of England, they previously would have had to post very safe assets, such as government bonds, as collateral.


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