WEEKLY COMMENT 31-10-2013

WEEKLY COMMENT 31-10-2013

By Barry Edwards

‘We Are Open for Business’ says the Governor

Mark Carney, the new Governor of the Bank of England (BofE) gave a speech at an event to celebrate the 125th anniversary of the Financial Times. He gave a good description of the problems created by the financial crisis and the steps that have been taken to prevent a disaster like that happening again. He also explained how the BofE will be much more proactive in financial markets and provide liquidity to all involved in the financial system without the stigma that has traditionally prevented banks from accessing the facilities of the BofE in the past.

You can read the whole speech if you click on the link below and you can also watch a video of the speech if you go to the BofE website.

http://www.bankofengland.co.uk/publications/Documents/speeches/2013/speech690trans.pdf

The Governor’s approach and style is much more enlightening than his predecessors and he went to some lengths to explain how the BofE would work much more closely with banks and those firms active in financial markets. Although it is refreshing to see a financial regulator be much more open and willing to comment on day to day affairs, the part of the speech that caught my attention was the paragraph below

‘Five simple words describe our approach: we are open for business.

Our facilities are not ornamental. They are there to be used by banks to access money and high-quality collateral. We are offering money and collateral for longer terms. The range of assets we will accept in exchange will be wider, extending to raw loans and, in fact, any asset of which we are capable of assessing the risks. And using our facilities will be cheaper. In some cases the fees are being more than halved.’

During the financial crisis, the BofE was forced to accept collateral in exchange for liquidity which was of much lower quality than government and AAA rated corporate bonds that were the norm. This meant that it was and still is holding some of the securitised mortgage bonds that were the cause of the problem. Admittedly the loan to value ratio was around 50-60 % of redemption value but this started the opening up of the kind of collateral that was allowed to be used in this way.

In fact, all the major central banks have adopted this strategy to improve the day to day liquidity in the system. The reason I find the governor’s statement above particularly interesting is that this could mean that loans to SME’s could be securitised and used as collateral to increase the lending capacity of this sector. This would be an excellent way of extending the BofE facilities beyond the ‘funding for lending’ scheme to lenders in this market who are not banks; it would really make a difference and help to increase the number of lenders to SME’s.

This new approach would need to be structured in a way that convinced the BofE that the underlying loans were properly constituted and there was some kind of monitoring to confirm the quality of the collateral. All of that is perfectly possible as we discussed last week and the lenders would have to accept that the monitors are relevant and link up with them in a helpful way.

It is likely the BofE would want to allow some leeway for problems and insist on a loan to value of around 70-80% and there would also have to be a rating system based on the asset value of the companies. One big advantage, if this market did evolve, would be the term of loans would extend beyond 5 years which is about maximum at the moment to 10 or maybe 15 years. Loans of this length of time would transform the SME funding market and allow long term planning for capital investment. Most of these loans would be securitised and sold as bonds to institutions.

In my view, this would stimulate SME’s to realise that they can make long term plans and the growth that would be generated once this strategy got underway would make a real impact on the British economy not seen for many years.

This is all speculative thinking within the bounds of reality and with luck it could encourage established lenders to open up their minds and except the new concept; it looks as if Mark Carney is willing to inspire the financial community to think outside the box.

If you have the time to read the Governor’s speech I recommend that you do since it is the first time someone in the position of authority has been willing to explain the new approach that has been taken by the BofE and the new team they have in place. It promises to be much more supportive of growth in the economy of the country and provide a more accommodating structure to financial markets and lending in general.

That’s all for this week, more observations next week.