A major investment bank believes UK banks will have tapped the Bank of England’s special liquidity scheme to the tune of over £200 billion by the time the drawdown period ends in October. To put this into context, £200 billion is the equivalent of 14% of annual GDP or 6% of banks’ and building societies’ total sterling liabilities.

According to the interim Crosby report on mortgage finance, outstanding UK residential mortgage-backed securities and covered bonds totalled £257 billion at the end of last year. The Financial Times reported in May that banks had created almost £90 billion of additional securities for use under the scheme. So there is sufficient paper available for the £200 billion estimate to be plausible.

However, it is difficult to find corroborating evidence of activity on this scale from Bank of England data on banks’ assets and liabilities. Banks obtaining Treasury bills under the scheme would be expected to use these as collateral for increased repo borrowing. Yet official data show a fall in banks’ repo liabilities of £33 billion between March and July.

It is likely that banks are channelling their SLS activities through off-balance-sheet entities. Such entities were previously used to issue RMBS to the market, with the proceeds routed back to the related bank. They may now be borrowing in the repo market using Treasury bills obtained under the SLS, again on behalf the parent bank. Consistent with this hypothesis, “intermediate other financial companies” increased their deposits with UK banks by an estimated £38 billion in the second quarter. As argued previously, this has resulted in a major upward distortion to M4 money supply growth.

If confirmed, would SLS take-up of £200 billion imply a significant beneficial impact on UK banks? To the extent that the scheme allows banks to avoid a step-up in funding costs when existing wholesale borrowing matures, the effect is to prevent further damage rather than provide a positive benefit. However, it should also have allowed some banks to reduce their average cost of funds.

The scheme is generating significant profits for the authorities. The fee charged on borrowings of Treasury bills is the spread between three-month LIBOR and the three-month general collateral gilt repo rate – currently 70 bp. Assuming an average spread of this level in the first year, and borrowing of £200 billion, the Bank of England would earn £1.4 billion from operating the scheme. This is a multiple of the income the Bank generates annually from its main revenue source, the system of cash ratio deposits, under which banks are required to hold a proportion of their eligible liabilities in a non-interest-bearing deposit at the Bank. SLS profits will presumably be remitted to the Treasury.