Bond swap risk stays on the balance sheet

Bank of England

Banks are to retain the risk of asset-backed securities on their balance
sheets as a condition of the loan of government bonds, it emerged this week as
the Treasury thrashed out a deal to inject £50bn worth of liquidity back into
the markets.

Chancellor Alistair Darling this week proposed a £50bn bond swap – in
exchange for assets which banks have been unable to sell or pledge as security
to raise funds.

But experts warned that the obligations on banks to disclose their losses –
from structured vehicles kept off the balance sheet – will remain.

‘The banks will borrow government bonds, using their asset-backed securities
as collateral. The idea is that the government bond will act as liquidity for
the banks, but the risk of that asset will remain with the banks and will stay
on their balance sheet,’ said Andrew Spooner, partner at

‘This means that all disclosures and fair value measurements will continue to
be with the banks,’ he added.

He said that if the value of the collateral falls, then the banks could have
to reimburse the Bank of England in cash.

The swaps will be for a term of one year, during which time the banks may be
able to renew them each year for, at most, a total of three years.

Banks will be able to swap securities formed only from loans that were
already on their balance sheets at the end of 2007 to prevent them relying on
the scheme to finance new lending.

The move, which mirrors the actions taken last month by the
US Federal Reserve
which swapped $200bn worth of securities, has been welcomed by the market which
is estimated to have lost $288bn globally in write downs.

Fair value measurements during the credit crunch have been repeatedly
slammed, with senior UK groups like the
Group of Finance Directors
questioning ‘mark-to-market’ accounting, and US
investment banks called for suspension of the standard.

But Darling warned this week that he expected banks to ‘begin now to disclose
the extent of their losses and explain how they are going to rebuild their

Related reading

PwC office 2