Bank of England weighs rule change to boost gilt demand

The Bank of England is set to address these leverage rules in its mid-year Financial Stability Report this Tuesday. Currently, banks are required to maintain capital worth roughly 3.25% of their assets. Barclays estimates that excluding unencumbered gilts from this calculation could encourage lenders to absorb up to £150 billion in additional government debt, potentially lowering yields by a fifth of a percentage point. Lloyds analysts echoed this sentiment, noting that even a more modest £30 billion increase in demand would provide significant relief to public finances.

Despite these potential savings, the proposal has encountered stiff resistance from those wary of repeating past financial crises. David Aikman, a former BoE regulator, likened the potential exemption to removing the batteries from a fire alarm. He argued that gilts are not strictly risk-free and that deepening the ties between bank balance sheets and government debt mirrors the vulnerabilities exposed during the euro zone crisis. Instead of granting exemptions, Aikman suggests the central bank should focus on recalibrating existing risk-weighted capital rules.

Beyond the debate over debt holdings, the Bank of England remains focused on the broader stability of the gilt repo market. With aggregate net borrowing reaching £74 billion in March, officials are concerned that the sector's reliance on a concentrated group of hedge funds could trigger liquidity issues during a market shock. Deputy Governor Sarah Breeden has signaled that regulatory intervention is likely, as the bank continues to stress-test the resilience of private markets against geopolitical instability.