Memorandum by the Public Works Loan Board
(PWLB) (LAI 44)
Thank you for your e-mail of 4 March about
the CLG Select Committee's inquiry into local authority investments.
You say that in the written and oral evidence reference was made
to the Public Works Loans Board as follows:
A number of local authorities have said that
changes to the arrangements for the early repayment of PWLB loans
have made it too expensive for local authorities to repay debt,
and have therefore found it less advantageous to repay a debt
than to hold cash on deposit alongside the debt. This has resulted
in local authorities having more cash to invest in the money market
than might otherwise have been the case. The PWLB change introduced
from November 2007 has meant that a significant penalty is
imposed if an authority seeks to repay a fixed rate PWLB loan
early and the arrangement retrospectively applies to all loans,
including those taken out before the PWLB rules were changed.
It may be helpful if I answer by explaining
the history and statutory background to the Public Works Loan
Board, and then turn to the changes introduced in November 2007.
Background
The PWLB is an independent statutory body dating
from the eighteenth century and in its present form from 1875.
It is headed by Commissioners, who are unpaid. Their function
is to consider loan applications from prescribed bodies and where
loans are made to collect the repayments. Nowadays almost all
loans are to local authorities only, for capital purposes. Since
2002 the secretariat of the PWLB has been a unit of the UK
Debt Management Office (DMO), operating from its offices in the
City.
The Board publishes an Annual Report, which
is laid before Parliament, and its accounts are audited by the
National Audit Office. The Secretariat has four staff, plus IT
support. Such economical management has come about over the years
because: loans can be agreed with the minimum of scrutiny; there
is a homogenous client base with very low credit risk; and operations
lend themselves to computerisation. The amount of outstanding
PWLB loans is £51 billions. The cap on the outstanding
amount has recently been raised by secondary legislation to £70 billions.
DMO sets the Board's rates of interest according
to methodologies which have been agreed with HM Treasury and are
designed to protect the National Loans Fund, which is the source
of PWLB funds and into which repayments are made. It is because
the Board in effect on-lends the Government's own borrowings that
rates are set according to the Government's cost of borrowing,
plus a small margin. The effect of this is that local authorities
can borrow at rates close to those at which the Government itself
may do so, but it also means that the range of instruments that
the Board can offer is limited to the basic and standard. The
Board's function is to provide capital finance to local authorities,
not to be an active treasury management counterparty. While the
Board is open to requests to make early repayments, its terms
will not favour the borrower over the National Loans Fund. This
is because there is a working assumption that the NLF continues
to meet the cost of financing the amount outstanding.
November 2007 Changes
With effect from November 2007 DMO/PWLB
has determined two sets of rates, one for new advances and the
other for early repayments. The spread between the two is to take
account of intra-day volatility and to compensate the NLF for
the risk posed by mismatches in timing and maturity by pricing,
albeit imprecisely, the option that local authorities have to
repay early at discretion. The two sets of rates were introduced
as part of a package of measures to remove pricing anomalies which
had in some instances created the potential for ex ante
risk of loss to the NLF, but the package also included features
which benefited borrowers by facilitating finer rates for advances
. DMO/PWLB stated at the time of the changes that they were not
intended to remove local authorities' opportunities for restructuring
debt, and so it has proved. For example, in January, albeit an
exceptionally busy month, borrowers repaid 437 loans early,
amounting to principal of £2,628 millions and thereby
realising discounts of £21.2 millions. It is probable
that this activity was related to the poor rates currently available
for investment deposits.
I and my DMO colleagues are in frequent contact
with the local authorities' representatives and advisers, including
the Committee's witnesses. We are aware of their concern, particularly
at the size of the spread at the long end of the rate curve. We
remain open to suggestions as to how PWLB can improve its service
to borrowers, subject to the overriding need to protect the NLF
from loss.
I hope this is helpful. Further information
on the Board's activities, interest rates etc is available on
the Board's website, the address for which can be found at the
head of this letter.
13 March 2009
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