An Eighties Revival Could be the Future of Liquidity

Published in the Financial Times 9 October 2008

From Mr John Grout

Sir, The UK authorities' welcome injection of money into the banking sector yesterday will take a while to work through the financial system.

Meanwhile, corporate borrowers have recently seen a restriction of access to wholesale money markets other than at the shortest maturities ("Banks invoke right to pass on rising cost of funding", September 30).

The Bank of England last week acted to tackle the shortage of banks' collateral for its temporary three-month facilities.

But go back to the 1980s. There was too much collateral discounted at the Bank of England (and it was of varying maturities of up to six months) - the much criticised "bill mountain".

Little used today in corporate funding, bankers' acceptances, bills relating to current trade, and banks' purchase of trade bills drawn and accepted by companies used to be important. Much of this was under uncommitted arrangements, but a "bill alternative" was a standard feature of bank loans, including syndicated loans. Bills could be rediscounted with the Bank of England by the discount houses. There was no shortage of collateral to finance trade and banks did not incur high premiums.

We now have universal banks, and the accepting house/discount house distinction is no longer with us. Paper bankers' acceptances have been replaced by a form of "two name" eligible debt security issued, traded and settled through the Crest system.

Banks should welcome an alternative to "London interbank offered rate-plus" financing in lending to companies. They could reinstate the alternative in modern loan agreements or make alternative facilities available in exchange for suspension of lending obligations. The definition of what is eligible for discounting at the Bank of England has already been widened and could be extended.

Even in the early 1980s, the value of bills outstanding was small in relation to total money market flows, but it did ensure that money got through from the central bank to the commerce that needs it.

A simple mechanism for the Bank of England to provide liquidity through the banking system to sound companies for periods of up to six months on a permanent basis seems to be available. Something for the Bank to consider as it works through the current crisis?

John Grout
Policy and Technical Director
The Association of Corporate Treasurers
London EC2, UK

See also Reintroduction of bankers’ acceptances market