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British banks gorge on European Central Bank's cheap credit

Section: Daily Dispatches

By Ambrose Evans-Pritchard
The Telegraph, London
Monday, October 1, 2007

British lenders are shunning the Bank of England and turning instead to the European Central Bank on a massive scale, taking advantage of much lower interest rates and guaranteed anonymity to weather the credit crunch.

EU sources say Britain's banks have been clamouring for money in Frankfurt, accounting for a substantial chunk of the E190 billion (L132 billion) lent last week in the ECB's variable tender operation. "It is fair to say they have been borrowing from the ECB on a very large scale. It's cheap, so why not?" said one official.

The UK banks were also major subscribers at the E50 billion issue of three-month loans on September 27 at 4.63 percent, and the earlier tender of E75 billion on September 13.

Hans Redeker, currency chief at BNP Paribas, said British reliance on ECB funds has become to big that it is leaving a clear footprint in the currency markets, forcing up sterling on the days following ECB tenders as the banks switch euros into pounds -- typically Thursdays, Fridays, and Mondays.

"There's been a huge amount of borrowing. It is causing movements in the euro-sterling exchange rate that do not make any sense otherwise. It is why the pound shot up in early September when the liquidity crisis was in full swing and there was nothing to justify this," he said.

"The money markets may look as if they are functioning again in Britain, but in reality they are not," he said. Mr Redeker believes that the key motive in going to Frankfurt is the certainty of secrecy, rather than the lower interest rate.

"Nobody wants to take up the Bank of England's three-month tender because of the stigma. They will be punished immediately by the markets," he said.

While the Bank of England says it will not publish names, there are concerns that the British press will unearth the story somehow. It is safer to stick to Frankfurt, where the ECB does not even reveal the nationality of banks coming to the window -- masking the picture.

The German press has reported that Barclays Capital in a major borrower at the ECB tenders. The bank has declined to comment.

Any British lender with a branch in the euro-zone can use the ECB facility, provided it meets the rules and offers the right collateral -- which includes mortgage-backed securities. The Bank of England was much more restrictive in the early phase of the credit crunch.

Some 1,676 banks are registered. Northern Rock is not one of them. It has an operation in Dublin but this is not set up as an autonomous branch under EU rules; otherwise the Newcastle bank could have borrowed funds much earlier, more cheaply, and used lower-grade collateral -- which together might have helped it avoid the calamitous run by depositors.

The heavy use of ECB credit has made it hard for the Bank of England to discipline banks. It has led to a war of words between the two institutions, with London reproaching Frankfurt for laxity and moral hazard, and Frankfurt retorting that London had allowed a manageable problem to mushroom into a disaster.

The British Banking Association said it was inevitable that UK lenders would turn to Europe in these conditions. "It's a no-brainer," said chief executive Angela Knight.

"If you look and see what the interbank rate is in euroland, it's much better than in the UK, so what of course has been happening is that, because the banks operate in multiple jurisdictions, they have taken a straightforward commercial decision. If the price of money looks better overseas, then that's where you're going to get it," she said.

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