United Kingdom: Discount Window Facility

The initial market notice establishing the DWF stated that the purpose of the facility was to “provide liquidity insurance to the banking system,” while noting that it was “not intended for firms facing fundamental problems of solvency or viability” (Bank of England 2008b). In the words of a Bank of England official, the “DWF is intended to act as a bridge in the event of a liquidity shock” (Fisher 2012).

The DWF served as a “liquidity upgrade” facility, swapping highly liquid and high-quality government securities for less liquid eligible collateral (Bank of England 2008b).

The Bank of England has the authority to provide liquidity insurance to the banking sector through liquid securities under its financial stability objective. The Sterling Monetary Framework is the published framework for the Bank’s market operations. The Discount Window Facility was, and continues to be, a part of the Sterling Monetary Framework, which includes the Standing Facilities (Bank of England 2008a). The Bank never refers to specific legislation in any of its discussion of the DWF, and research could not determine legislation that narrowly authorized a program like the DWF. The Winters Review, which analyzed the Bank’s approach to liquidity provision, never mentioned legislation or statutory authority, instead focusing on the wide range of authority vested in the Governor of the Bank (Winters 2012). Therefore, it seems likely that the Bank is relatively unrestricted in its power to implement lending programs.

The Bank of England utilized lessons learned from the Special Liquidity Scheme (SLS), implemented in April 2008, to construct the DWF. The SLS functioned as a temporary solution to pressures on the banking sector, providing liquidity against newly illiquid legacy assets (Fisher 2012). It served as a collateral swap, with institutions obtaining nine-month Treasury bills in return for high quality mortgage-backed and other securities for a three-year term (Plenderleith 2012).

The Bank of England structured the DWF to operate as a “liquidity upgrade” mechanism similar to the SLS through a collateral swap, with banks swapping illiquid assets for government securities (Fisher 2012). Also following its SLS experience, the Bank of England did not release individualized DWF usage data in order to avoid stigma from usage (Winters 2012).

In October 2008, the Bank of England split its bilateral Standing Facilities into Operational Standing Facilities (OSFs) and the DWF. The OSFs functioned similarly to the prior Standing Facilities, ensuring that short-term market interest rates did not deviate significantly from the Bank Rate while also providing liquidity insurance to firms facing technical problems in markets. The DWF instead served as liquidity insurance for idiosyncratic, system-wide shocks to the market, rather than frictional issues (Plenderleith 2012).

The Bank of England managed the DWF as it became an existing standing component of its operations (Bank of England 2008b).

After firms pre-positioned their eligible collateral at the Bank of England, they could initiate a drawing request from the DWF via telephone, which must be before 2 pm in order to guarantee settlement that day. The Bank of England recommended that participants call them as soon as possible on the day of the drawing in order to discuss their application (Bank of England 2008b).

The DWF served as an on-demand facility with set fees, rather than utilizing an auction format. See Figure 1 for a graphical representation of how drawing on the DWF works.

Source: Bank of England 2021.

Banks with eligible liabilities greater than GBP 500 million had to place at least 0.11% of their eligible liabilities in cash ratio deposits (CRDs) at the Bank of England. CRDs are non-interest-bearing deposits that fund the central bank’s operations (Winters 2012). Institutions with eligible liabilities less than GBP 500 million were not required to place deposits with the Bank of England. In October 2009, the Bank of England expanded counterparty eligibility to include all institutions that were required to report their eligible liabilities to the Bank of England. If a newly eligible institution was granted access to a Sterling Monetary Framework facility, they had to place a non-interest-bearing deposit with the Bank of England in the amount of at least 0.11% of their eligible liabilities, with a minimum deposit of GBP 200,000 (Bank of England 2009h).

The Bank of England did not guarantee that counterparties could always access the DWF, deciding at the time of each application for a drawing if a counterparty was solvent and viable (Fisher 2012).

Participants in the DWF could borrow HM Government gilt-edged securities from the Bank of England against eligible collateral (Bank of England 2008b). The Debt Management Office (DMO), an executive agency of HM Treasury, lent these gilts to the Bank of England so that the Bank of England could administer the DWF. In conjunction with the announcement of the DWF in October 2008, HM Treasury created and issued GBP 47.8 billion of gilts to the DMO to fund the DWF (Debt Management Office 2010).

The Bank of England did not announce a predetermined size or cap on the DWF. Based on the amount of collateral pre-positioned in the DWF as of 2012, the Bank of England estimated that GBP 160 billion could be lent through the DWF in 2012 after the requisite haircuts had been applied to the eligible collateral. This number does not appear to be a hard limit on DWF lending, but rather the Bank of England’s estimate of the floor of lending capabilities prior to conducting detailed collateral checks (Fisher 2012). Paul Fisher, member of the Monetary Policy Committee, said that the Bank of England has been “encouraging banks to ‘pre-position’ their collateral,” while the “pre-positioning drive has gathered pace in the last year or so [2011–2012]” (Fisher 2012). However, there is no public data on the pace of pre-positioning of collateral. In October 2012, the Bank of England reported that the DWF had not been used (Winters 2012).

The Bank of England never established individual participation limits for the Discount Window Facility, as it was an on-demand facility.

The rate charged to participants in the DWF was the indexed Bank of England rate plus a fee, which varied by type of eligible collateral and the amount of DWF borrowing relative to the institution’s balance sheet (Bank of England 2008b). The fee increased as the type of collateral became lower in quality and as the size of drawings increased. For DWF drawings greater than 30% of the institution’s balance sheet, the fee was within the Bank of England’s discretion without a set guideline.

The Winters Review (2012) found that the DWF charged penalty rates, which came into effect when counterparties borrowed greater sums or used less liquid collateral. The equivalent Federal Reserve facility charged a rate significantly lower than the DWF, while market rates never came close to the DWF rates. This likely led to low usage as potential counterparties had access to private funding at much lower rates.

The Bank of England calculated the fee based on the total market value of outstanding gilts in the DWF drawing each day. If a firm positioned a “mixed bucket” of collateral (a variety of different levels of collateral), the collateral from the more secure level was used first (Bank of England 2008b). The fee was payable on the first business day of each month or maturity of the final DWF outstanding drawing (Bank of England 2008b). The variable fees are listed in Figure 2 below.

Source: Bank of England 2008b.

Initially, the assets eligible for collateral in the DWF were divided into four levels (Bank of England 2008b). These were the widest sets of collateral accepted by the Bank of England for its liquidity facilities (see Figure 3).

• Level A consisted of high-quality debt securities that were eligible as collateral in the Open Market Operations and Operational Standing Lending Facility.
• Level B consisted of third-party debt securities that were trading in liquid markets, according to the Bank’s discretion.
• Level C consisted of third-party debt securities that were not considered to be trading in liquid markets.
• Finally, Level D consisted of own-name securities and own-name covered bonds, which were assets that the borrowing bank either originated or were closely connected to the borrowing bank and could compromise the collateral. Level D was expanded in April 2011 to include portfolios of unsecuritized loans (Plenderleith 2012).

The Bank of England allowed for this possible adjustment in the initial market notice announcing the DWF (Bank of England 2008b).

Note: Collateral of all four levels were eligible for the Discount Window Facility.

Source: Winters 2012.

The Bank of England published margin ratios rather than haircuts for eligible collateral.^FNAdjusted collateral value (post-haircut) = collateral value x ([ 1 / margin ratio ] – haircut add-ons) (Bank of England 2008b). Figure 4 illustrates the margin ratios to be applied to collateral given by the first Market Notice announcing the DWF. They range from 1.06 to 1.82, depending on the quality and maturity length of the collateral. The Bank of England reserved the right to alter the margin ratios, as well as apply additional haircuts at its discretion (Bank of England 2008b). The initial Market Notice provides conditions for additional haircuts:

• Haircut add-on of 3pp [percentage points] if the securities are non-sterling to counteract currency risk;
• Haircut add-on of 5pp on own-name eligible covered bonds, RMBS, CMBS, ABS, and portfolios of corporate bonds where appropriate;
• Haircut add-on of 5pp on eligible collateral without an observable market price;
• Haircut add-on of 5pp on eligible covered bonds, RMBS, CMBS, and ABS that have been downgraded from AAA to Aa/AA; a further 5pp would be added for eligible covered bonds, RMBS, CMBS, and ABS that have been downgraded from AAA to A (Bank of England 2008b).

Initially, the Bank of England set the maximum term available for a drawing from the DWF at 30 days (Bank of England 2008b). The Bank of England eventually expanded the options to include a term of 364 days, with effect from February 2, 2009. This longer term required borrowers to pay an additional fee of 25 basis points (Bank of England 2009c). The borrowers could repay the drawings at any point (Bank of England 2008b).

Firms that borrowed from the DWF could not (and cannot) use the gilts as collateral for the Operational Standing Facilities in an attempt to exchange their DWF collateral for cash; there was a limited option to receive cash under the DWF at the borrower’s request and at the Bank of England’s discretion. However, the gilts could (and can) be used as collateral for loans under the Bank of England’s Open Market Operations. Firms cannot use the DWF as a means to receive specific gilts, as this would be a violation of the purpose of the DWF (Bank of England 2008b).

There is no publicly available information on other options considered by the Bank of England. However, the Bank of England utilized lessons learned from the SLS in order to inform the design of the DWF (Fisher 2012).

The DWF was not designed to have an effect on the monetary supply, since gilts are swapped for eligible collateral (Bank of England 2008a). However, the Bank of England has the ability to provide “at its discretion, in exceptional circumstances” sterling cash reserves rather than gilts (Bank of England 2008b).

By swapping gilts for eligible collateral, the Bank of England could provide liquidity to the banking system without affecting its balance sheet, since such transactions would occur off balance sheet. The DWF reported zero usage during the entirety of the Global Financial Crisis, leaving no effect on the balance sheet of the Bank of England (Winters 2012).

The Bank of England did not design the DWF in conjunction with similar facilities in other countries.

The Bank of England released a consultative paper, titled “The Development of the Bank of England’s Market Operations,” on October 16, 2008. This paper laid out the preliminary structure of the DWF, along with other strategies for supporting the market. The paper announced that a market notice would be released on October 20, 2008, establishing the details of the DWF (Bank of England 2008a). The Bank of England announced occasional changes to the DWF structure in later Market Notices, with important changes discussed previously.

Paul Fisher, Executive Director for Markets at the Bank, gave speeches in 2009 and 2012 that detailed the purpose and structure of the Discount Window Facility. Both of these speeches reiterate that the DWF is structured to be a relatively costly facility, in order to ward off moral hazard risks (Fisher 2009; 2012). In the 2012 speech, Fisher notes that the DWF is only a crisis tool, stating that the DWF is:

The Bank of England did not provide individual institution usage for the DWF. Instead, the Bank of England averaged aggregate usage across counterparties over each three-month quarter. For drawings with an initial maturity of 30 days or less, the aggregate data would be published at the end of the next quarter (i.e., data for January-March would be released at the end of June). For drawings with an initial maturity of up to 364 days, aggregate data would be released five quarters later (Winters 2012).

The original Standing Facilities, which the Bank of England split in the DWF and OSF, faced serious stigma issues. In 2007, the media’s discovery of Barclays’s usage of the Standing Facilities resulted in a severely negative market reaction, which led to the split of the facility in order to fix any further stigma issues that arose from the Barclays exposure (Winters 2012).

The DWF was not used during the Global Financial Crisis, partly due to stigma concerns. Counterparties worried that usage of a bilateral, on-demand, liquidity facility would be a sign of weakness and insolvency, despite the DWF excluding insolvent firms from participating. However, Paul Fisher, member of the Monetary Policy Committee, stated that the Bank of England expected that firms in need of DWF would draw on it, regardless of any stigma concerns (Fisher 2012).

The stigma concerns held by potential counterparties were driven by four particular issues: a penalty price on usage, the requirement of a repayment plan submitted with a drawing request, a solvency and viability test on the day of drawing, and its bilateral nature (Winters 2012). Additionally, it is possible that the wide set of collateral eligible for the DWF led to stigmatization, as it could be viewed as an extreme measure.

In order to lessen the stigma attached to the DWF, the Bank of England only disclosed anonymous lagged usage data, with DWF drawings only disclosed after their terms completed. Furthermore, the drawings would not show up on the Bank of England’s balance sheet, since the DWF functioned as a liquidity upgrade (Fisher 2012).

There is no end date for the DWF since it is intended to be a permanent standing facility (Plenderleith 2012).