Thursday, 20 March 2008

The Bank of England's balance sheet - we should look at it a little more closely

You will need to click on the image to get a sharper image.

Here is the latest consolidated balance sheet from the Bank of England. Normally, central bank accounting would not attract any attention. However, these are not normal times.

I will admit to having a less than complete understanding of this balance sheet. I have posted it in the hope that it might inspire a discussion and perhaps gain more clarity.

Here is what I see. First, all the action is on the asset side of the statement. The main aggregates on the liabilities side seem rather stable.

On the assets side, we can easily see the Northern Rock bail out. It is found in the other assets category. That number has exploded since mid-2006. Based on the changes in this item, it would seem reasonable to conclude that the Bank of England has pumped in about ₤32 billion since the bank sank into insolvency.

The other interesting lines are sterling long term reverse repos, and fine tuning reverse repos. Both are positive, Here is where the Bank of England are accumulating assets through providing liquidity. In other words, the bank has taken assets from commercial banks and given out "something". What that "something" is not immediately obvious.

Lets exclude the obvious. It is not cash. If you look on the liabilities side; sterling notes has actually fallen ₤4 billion.

The liquidity is coming from the asset side of the balance sheet and it seems to be coming from two items: a) the ways and means account, which I think comprises of government securities; and b) short term market operations with BoE counterparties.

This latter component sounds like it might government paper taken in by the central bank as part of normal open market operations. In the past, the BoE would have accepted government securities when the banks needed cash. Now, the banks are getting them back through reserve repos. However, I am far from confident in these conclusions and would be happy to be corrected.

One thing is clear, however. The Bank of England's operations have not expanded high powered money. These liquidity operations are very similar to those currently being undertaken by the Federal Reserve. Rather than providing cash, the central bank is providing high quality assets in return for weaker ones.

As you can see, a fair proportion of the Bank's assets are now tied up with bailing out the UK banking system. I estimate that around ₤54 billion out of total assets of ₤97 billion are now being used to prop up the banking system.

7 comments:

Josh said...

You have lost me on this post. So what are the BoE doing? What is liquidity? Reserve Repos?

Anonymous said...

Josh, you are thick.

tom said...

Good analysis. I think the answer lies in the fact that short-term market operations and long-term reverse repos have balanced each other. In other words, the BoE is now providing more long-term liquidity to banks whereas before it was providing more short term. But overall the two balance, so the BoE hasn't really pumped any new money into the system at all, despite screams in the press to the contrary.

If the BoE decided to expand high-powered money (i.e. fire up the printing presses), inflation expectations, and therefore yields on government debt, would rocket upwards. So that is not really an option for the BoE - which means their ability to bail out the market is constrained by their balance sheet, which as you point out is already pretty tied up. They have very little room left for manoeuver - another Northern Rock and the BoE wouldn't be able to help out this time around.

Anonymous said...

I read and replied to your rather interesting post about M4 on HPC... I've been thinking about this lots too. It has been discussed at length on HPC, but - back then - I had no well formed ideas, and I went along with consensus - which, I now think, was utter twaddle. The thread has now been taken over by monkey-videos and cartoons of fat-cats... so my reply might easily be missed. :)

I'd be very interested to hear your thoughts on this:

http://www.housepricecrash.co.uk/forum/index.php?showtopic=71519&st=15

I'd love to have the pre-requisite knowledge to test my hypothesis - it seems credible to me.

A Steve

Alice Cook said...

Steve,

I quickly saw your reply on HPC. However, I couldn't give it the attention it deserves, because I had to go and meet some people. However, I am going to look at it again.

My immediate thought was that the answer to your question is almost certainly found in banking sector behaviour. Therefore, it is necessary to look at the the underlyng aggregates of M4, which can been seen from two perspectives; deposits and lending. When time permits, I will do this.

BTW, there is an interesting paragraph in the last BoE inflation report, where the BoE staff basically admit that they don't understand M4. I have to dig it out and do a post.

Alice

ps sorry about the cats and monkeys.However, the clips were funny.

Alice Cook said...

Tom,

Thanks for the comments. The surprising things that come out of the BoE balance sheet are a) no increase in high powered money, b) big bail out using BoE assets.

However, a big chunk of the BoE balance sheet is now out there in the banks. If things carry on, Mervyn might run out of assets.

Alice

The Big B said...

Alice, where do you get the time to look at this stuff. I hope it is not during office hours.