Bank of England offers £50bn mortgage debt sticking plaster

The Bank of England is to allow banks to swap mortgage backed securities – at the nexus of the credit crunch – with over £50 billion worth of government bonds.

Chancellor Alistair Darling explained Treasury Bills would be swapped by the Bank of England and said he would urge banks to make mortgage borrowing easier for consumers.

"Banks are reluctant to lend to each other, and as result lending to customers is more expensive and more restricted," he told parliament.

"As banks here and across the world disclose their losses and strengthen their financial positions, which will help rebuild confidence, the Bank of England can now take action to ease conditions in the financial markets, particularly in relation to mortgaged backed securities."

The securities will be taken at a discount so the government is not seen to be offering aid, and will only be for a year – although they can be renewed for up to three years.

The Bank of England revealed if a bank provides £100 of AAA-rated UK residential mortgage-backed securities, it will, depending on the specific characteristics of the assets, receive between £70 and £90 of Treasury Bills.

It is thought banks will also be pushed to disclose more losses and turn to shareholders – as RBS is reported to be considering – to raise funds.

"The Bank of England believes that these measures will support the banking sector during the present period of uncertainty and will help restore the stability that the financial markets need now. Both now and in the longer term," the chancellor told parliament.

"This will help alleviate the problems that have seen banks reluctant to lend to each other and in turn support the provision of new mortgage lending."

Mr Darling added he would be working with the mortgage industry to ensure they treat customers struggling with mortgage repayments, as remortgage costs and rates rise, and treated fairly.

"I will be discussing how banks and building societies can help people whose fixed rate mortgages are coming to an end, as well as helping people who may get into difficulties in repaying their mortgages," he said.

"Banks and building societies have a duty to treat their customers fairly, and in the light of everything we are doing with them, I want to discuss with them how they can pass on the benefits of falling interest rates as well as wider Government support to mortgage holders."

George Osbourne, Tory shadow chancellor, called into question whether the offer would cover US securities based on credit cards and pointed out the deal lasts 364 days – so they are not classed as government debt, which they would after 365 days.

Mr Darling said it was down to the Bank of England to decide which securities to take – which could include triple AAA rated credit card securities.

Government bonds will have a maturity of up to a year - but can be renewed for a period of up to three years - meaning under existing accounting procedures they will not be considered part of the country's national debt.

A Bank of England statement said: "Banks can, for a period, swap illiquid assets of sufficiently high quality for Treasury Bills. Responsibility for losses on their loans, however, stays with the banks."

Mervyn King, governor of the Bank of England, said: "The Bank of England’s Special Liquidity Scheme is designed to improve the liquidity position of the banking system and raise confidence in financial markets while ensuring that the risk of losses on the loans they have made remains with the banks."

An initiative to help the banking system has been widely anticipated, after banks reportedly told prime minister Gordon Brown during a meeting at Downing Street last week that more had to be done to ease the credit crunch.

Banks have already withdrawn several mortgage products from the market and some are ignoring the most recent base rate cut.

The British Bankers' Association (BBA) now claims the action from the government will restore confidence on the money markets - which may eventually trickle through to better mortgage deals for UK borrowers.

A BBA spokesman said: "The banks are participating in this arrangement and expect it to make a significant contribution to alleviating the pressures in the UK money markets.

"Restoring confidence in the wholesale funding market will strengthen the financial system and the stability of our economy."

He added: "The banks will continue to work closely with the government, the central bank and the regulator to keep markets open and remove obstacles to ensuring that credit remains available to businesses and households."

US Federal Reserve chairman Ben Bernanke announced a similar move to US banks for troubled subprime loans earlier this month alongside measures to allow investment banks to borrow directly from the American central bank.

The inability of US homeowners to meet mortgage payments has led to global concerns as investment banks had created securities tied to these loans that were sold to investors and institutions around the world.

Financial institutions around the world have written off close to $200 billion (£100 billion) as housing investments turned worthless, with the world's biggest investment banks such as Citigroup, Merrill Lynch and UBS reporting quarterly losses in the billions due to the defaults.

Banks have hoarded cash since then in order to deal with their losses leading to a lack of availability of funds in the credit markets.

The relatively higher rate of interest charged on banks' lending to each other is a result of uncertainty in the global markets which the Bank of England is now acting to ease by offering bank's safe capital in exchange for assets of doubtful value.

Earlier this year, the government nationalised mortgage specialist Northern Rock as it struggled to finance itself in the wake of the credit crisis.