Since the credit crisis erupted commentators have frequently speculated that the Bank of England has advanced funds outside the framework of its normal money market operations to banks other than Northern Rock. There is no evidence from available sources of any sterling lending of this sort. However, the recently published Bank of England Annual Report shows that the Bank substantially increased its foreign currency lending to banks during its last financial year.

According to the Report, “loans and advances to banks” by the Bank’s Banking Department rose by £32.2 billion between 28 February 2007 and 29 February 2008 (from £31.6 billion to £63.7 billion – see note 10 on page 66). The weekly Bank Return indicates that the Banking Department’s money market operation loans (“sterling reverse repos”) were little changed between the two dates, while the Report also states that lending to Northern Rock stood at £24.3 billion on 29 February 2008 (note 29, section a) on pages 82-83). This leaves an “unexplained” increase in lending of about £8 billion.

Section d) of note 31 on pages 88-90 confirms that this represents foreign currency lending. Non-sterling “loans and advances to banks” increased by £8.2 billion over the year (from £10.8 billion to £19.0 billion). This was financed by an £8.5 billion increase in foreign currency deposits from other central banks (from £7.0 billion to £15.4 billion).

To a small extent, these rises reflect the currency translation effect of a weaker exchange rate. However, even if all the non-sterling loans were denominated in euros, this would account for only £1.4 billion of the £8.2 billion increase in foreign currency loans.

The “innocent” explanation for this lending is that foreign central banks asked the Bank of England to place foreign currency funds in the market on their behalf. However, it seems an unlikely coincidence that such a large rise occurred during a year when the banking system was under considerable stress.

More probably, the Bank borrowed under arrangements with one or more other central banks to onlend to banks in London facing difficulties raising foreign currency funds in wholesale markets. Such an operation would be similar to the currency swap between the Federal Reserve and the ECB and Swiss National Bank introduced last December and increased in size in March and May, under which the Fed advanced funds to be auctioned off to dollar-short banks in Europe.

Perhaps there is another explanation but this one fits the facts. It seemed strange at the time that the Bank of England was not involved in the announced Fed currency swap facilities. It may have chosen a more “covert” form of lending to avoid drawing further attention to UK banks’ difficulties after the Northern Rock debacle.