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Bank of England Unveils £5bn Lending Scheme

(c) Sky News 2012

The Bank of England (BoE) has confirmed it will set aside £5bn each month as part of a new lending scheme aimed at helping British banks.

The aim is to offer cheap cash loans to banks, to ease the flow of credit to the UK economy and reduce the funding squeeze which has been worsened by the eurozone crisis.

The lending scheme is called the Extended Collateral Term Repo Facility (ECTRF), and the first auction will be held on June 20.

The BoE then intends to hold one auction at least once per month until further notice.

The Bank plans to allocate £5bn every month, which can be lent to banks in the form of six month loans.

The commercial banks will in return have to offer a minimum of the prevailing official interest rate, currently 0.5%, plus 25 basis points to bid for the six-month loans.

Until now, the BoE could only provide these sort of funds through its so called discount window.

UK banks have been stocking up on cash because they fear that the eurozone crisis will become so bad that they will not be able to borrow what they need from normal creditors.

This will subsequently mean that they will not be able to lend money to consumers. 

The lack of lending to businesses and consumers is one of the drags on Britain's economy, which is stuck in its second recession since the onset of the financial crisis in 2007.

The costs bank face to refinance has risen since the euro crisis began to escalate last August, and in addition to that, the costs UK banks have faced have been significantly higher than their eurozone counterparts.

This is because the European Central Bank has pumped almost one trillion euros of three-year loans into the Eurozone system, which has driven down interbank lending rates to below official interest rates.

Since the ECTRF's launch last December, the BoE has been urging banks to "pre-position" their collateral with the central bank - in other words, let it know up-front what assets banks want to exchange for cash.

This has the advantage of speeding-up the delivery of the cash loan because it gives the central bank time to check the viability of the collateral being offered.