Bank of England Could Boost Bond Demand with Leverage Rule Tweak

• The Bank of England (BoE) could give Britain's government bond market a boost this week and lower public borrowing costs by more than £1Bn (US$1.3Bn) a year, banks say — but some former regulators warn a change in rules to achieve this would increase financial risks. The BoE is reviewing how its leverage ‌rules operate, which banks argue discourage them from holding public debt, after loosening its main capital requirement in December. It is due to give an update on its plans in its half-yearly Financial Stability Report set to be released this week.
• The central bank's review into leverage rules and other buffers follows a relaxation of U.S. leverage requirements in November, a development that increased competitive pressures for British lenders and potentially undermined broader resilience, nearly 20 years on from the global financial crisis.
• Barclays, with over 20 million United Kingdom (U.K.) customers, has called on the BoE to stop counting banks' holdings of British government bonds, known as gilts, towards a leverage ratio which requires banks to have capital worth somewhat over 3.25% of their assets to help cover any losses.
• A change here could encourage British banks to hold ⁠up to £150Bn more gilts, lower average yields by a fifth of a percentage point and save the government £2.5Bn a year in debt interest at a time of stretched public finances. This change should only apply to 'unencumbered' gilts, that is, those that banks are free to sell and are not already pledged as collateral in another transaction, Barclays added.
• Other banks see a sizeable, if smaller, gain too. Lloyds said a change might only lead to a £30Bn increase in gilt demand, but it still sees at least a £1Bn a year reduction in interest payments for the government — almost enough to cover a funding shortfall in defence plans recently announced.
• Since launching the review, the BoE has not said if it supports exempting gilts from leverage rules. However, Sam Woods, who was the BoE deputy governor for prudential regulation ‌until last ⁠week, told financiers in October that exempting all gilts from leverage rules "would be a profound and highly risky change". Woods has been succeeded by Katharine Braddick, previously a senior Barclays executive. Other former regulators have also voiced concerns.

(Source: Reuters)