The Bank of England is launching a scheme to inject more liquidity into financial markets by allowing banks to temporarily swap their high quality mortgage-backed and other securities for UK Treasury Bills.

Under the scheme, banks can, for a period, swap illiquid assets of sufficiently high quality for T-bills. Each swap will be for a period of one year and may be renewed for a total of up to three years. Responsibility for losses on their loans, however, stays with the banks. It suggested that about £50 billion ($101 billion) in swaps will be made.

“By tackling decisively the overhang of assets in this way, the scheme aims to improve the liquidity position of the banking system and increase confidence in financial markets,” the Bank said.

The Bank said that with markets for many securities currently closed, banks have an ‘overhang’ of these assets on their balance sheets, which they cannot sell or pledge as security to raise funds. This, in turn, has made banks reluctant to make new loans, even to each other.

Mervyn King, governor of the Bank of England, said “The Bank of England’s Special Liquidity Scheme is designed to improve the liquidity position of the banking system and raise confidence in financial markets while ensuring that the risk of losses on the loans they have made remains with the banks.”

Banks will be able to enter into new asset swaps at any point during a six-month window, starting today. During the lifetime of an asset swap, banks will be required to pay a fee based on the 3-month London interbank interest rate. Banks will be able to swap a range of high-quality assets, including AAA-rated securities backed by UK and European residential mortgages. But to prevent banks relying on the scheme to finance new lending, they will be able to swap securities formed only from loans that were already on their balance sheets at the end of 2007.

http://www.bankofengland.co.uk/publications/news/2008/029.htm