Interest Rate Question

[mik1973]

Trying to understand the direct influence the Bank of England has on interest rates and would appreciate answers to the following

Is this the rate at which banks borrow money from the BOE?

At what stage does "borrowing " from the BOE then change to the BOE becoming "the lender of last resort" (a la Northern Rock)

Would a bank ONLY approach the BOE if they were unable to raise funds via the wholesale markets or can they request funds directly.

Thanks in advance.

Mick

 

[RichieE]

Trying to understand the direct influence the Bank of England has on interest rates and would appreciate answers to the following

Is this the rate at which banks borrow money from the BOE?

Yes - It is the minimum rate at which banks can borrow from the Bank of England

At what stage does "borrowing " from the BOE then change to the BOE becoming "the lender of last resort" (a la Northern Rock)

That's a very good question. I would like to know the answer to this too...

 

[Rhody Trader]

At what stage does "borrowing " from the BOE then change to the BOE becoming "the lender of last resort" (a la Northern Rock)

Would a bank ONLY approach the BOE if they were unable to raise funds via the wholesale markets or can they request funds directly.

I don't know the exact mechanics of the BOE, but if it works like the Fed does then a bank can go there to borrow at the discount window any time. Doing so, though, requires a collateral deposit, whereas the normal Fed Funds market is unsecured lending. So if a bank can get a better rate from the Fed at the discount window than through the Fed Funds market (which is bank-to-bank) then it would make sense to do so. I'm thinking it works similarly in the UK.

That being the case, just going to the BOE doesn't make it a lender of last resort automatically. If, however, the bank cannot get anyone to lend to it, that's when the central bank takes on that role.

 

[RichieE]

That being the case, just going to the BOE doesn't make it a lender of last resort automatically. If, however, the bank cannot get anyone to lend to it, that's when the central bank takes on that role.

That implies that the BOE gives a loan to a company that has already been turned down for a loan from the BOE! Very interesting!

I'm not trying to be sarcastic... but trying to understand how this works. If the above is true, this suggests that a bank that doesn't meet the lending requirements for the BOE will be charged a punitative rate by the BOE. Am I correct?

 

[Rhody Trader]

That implies that the BOE gives a loan to a company that has already been turned down for a loan from the BOE! Very interesting!

I'm not trying to be sarcastic... but trying to understand how this works. If the above is true, this suggests that a bank that doesn't meet the lending requirements for the BOE will be charged a punitative rate by the BOE. Am I correct?

As I said, I'm not sure of the specifics with the BOE, but if it's like the Fed (and I believe that it's similar) then no.

The Fed Funds market is bank-to-bank. The member banks lend to and borrow from each other the reserves they are required to keep with the central bank. The Fed is not directly involved in that process - though it manipulates the market (buying and selling Treasury securities) to keep rates in line.

If a bank cannot borrow from one of the other member banks it is forced to go to the Fed's discount window. It's not a situation where a bank trys to borrow from the central bank, is rejected, and has to try again in a different manner, which is what it sounds like you are thinking.

 

[RichieE]

The Fed Funds market is bank-to-bank. The member banks lend to and borrow from each other the reserves they are required to keep with the central bank. The Fed is not directly involved in that process - though it manipulates the market (buying and selling Treasury securities) to keep rates in line.

If a bank cannot borrow from one of the other member banks it is forced to go to the Fed's discount window. It's not a situation where a bank trys to borrow from the central bank, is rejected, and has to try again in a different manner, which is what it sounds like you are thinking.

That's interesting. This implies that the Fed Funds rate is analogous to LIBOR since this is the 'Interbank' offer rate. However, the BOE sets the Bank of England Base rate, the minimum rate charged to banks wishing to borrow from the BOE, (i.e. not LIBOR). So this begs the following question...

Does the BOE have the right to 'refuse to lend' at the base rate and then charge a bank (e.g. Northern Rock) a punitative rate to act as a lender of last resort? If so, does that imply that there is a conflict of interest here since it will be in their best interest to charge the more expensive rate?

Does anyone have the answer?

 

[Rhody Trader]

That's interesting. This implies that the Fed Funds rate is analogous to LIBOR since this is the 'Interbank' offer rate. However, the BOE sets the Bank of England Base rate, the minimum rate charged to banks wishing to borrow from the BOE, (i.e. not LIBOR). So this begs the following question...

Right. Fed Funds is the market for bank reserves held at the Fed, while LIBOR is the rate for dollar deposits offshore - not Fed reserves, just regular deposits. But basically it's the same type of structure.

Does the BOE have the right to 'refuse to lend' at the base rate and then charge a bank (e.g. Northern Rock) a punitative rate to act as a lender of last resort? If so, does that imply that there is a conflict of interest here since it will be in their best interest to charge the more expensive rate?

Here's something that could come into play. The Fed and BOE (presumably) require collateral for discount window borrowing. Many times there is some kind of haircut assessed - meaning they don't lend the full value of the collateral. The lower the quality of that collateral, the larger the haircut. That's one part of the equation. The other part could be something related to the financial condition of a bank. If certain financial criteria are not me, the CB may have the authority to charge a higher rate. I haven't heard that happening regarding the Fed, but then they haven't had to deal with the likes of a Northern Rock situation - at least as yet.