BoE Exposed to Higher-Risk Assets as Banks Pledge More Collateral

British banks are increasingly pledging higher-risk assets as collateral at the Bank of England. The central bank's Indexed Long-Term Repo (ILTR) auction saw £1.9 billion in Level C collateral pledged on August 18, its highest amount since March 2020 and three times that of the previous week.

The BoE has about £17.8 billion of Level C collateral on its books from the ILTR, up from £8.7 billion a year ago and under £1 billion in mid-2024. This exposure to higher-risk assets is raising concerns about the central bank's risk management.

Securities issued by Harben Finance, which is controlled by Barclays, are among those on the BoE's Level C list. These debt products package up and sell loan payments from buy-to-let mortgages originated before 2008.

The European Central Bank has tightened its criteria for acceptable collateral in recent years, disallowing certain debt products that were previously accepted. The BoE accepts a range of assets that the ECB has disallowed, including some mortgage-backed debt and loans linked to high-interest store cards and vehicle leases.

William Allen, a visiting fellow at the National Institute of Economic and Social Research, warns about the risk that encouraging bad lending could pose if the BoE takes on too much Level C collateral. The central bank charges banks a higher interest rate and applies a bigger 'haircut' to riskier assets to protect itself from losses.