Central bank intervention
103. The 'liquidity freeze' facing banks during 2007
led some UK banks to request additional liquidity from the Bank
of England in August 2007, at zero penalty rate. As we discussed
in The Run on the Rock, the Bank of England refused to agree to
the banks' requests for three reasons: the banking system as a
whole was strong enough to withstand the problems on its own;
secondly, banks would gradually re-establish valuations of asset-backed
securities, thus allowing liquidity to build up again; and thirdly,
there would have been a risk of moral hazard if the Bank had given
the banks what they asked for.
104. Meanwhile, other central banks appeared to be
more proactive in their response to the unfolding events. In the
Run on the Rock we set out the different responses of the US Federal
Reserve and the European Central Bank to liquidity problems in
August 2007, and concluded that the Bank of England paid too much
attention to the risk of moral hazard and should have adopted
a more proactive approach.
105. However, the Bank of England later softened
its position—agreeing to extend the range of collateral
it would accept in providing liquidity to the banking sector on
20 September 2007. We concluded that such a facility should have
been granted at an earlier stage. Subsequent actions by the Bank
of England, including a coordinated operation by major central
banks from around the world, are discussed in the next chapter.
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