Banks Are Handing Riskier Loans to the Bank of England for Cash

What happened

Banks have been pledging riskier loans to the Bank of England in exchange for cash through the Indexed Long-Term Repo, a liquidity backstop that runs weekly and lets lenders borrow for six months. The facility accepts three grades of collateral, and the lowest rung - Level C - is the one gaining ground.

This week's auction totaled £1.2 billion, an 80% jump from the prior month. At points in October, Level C made up almost half of all collateral posted. Bloomberg's calculations show Level C use has now risen above £19 billion.

How the ILTR works and why banks are using it

The BOE's aim is to let banks source reserves for payments and precautionary needs, not just in emergencies. It already removed the stigma around using its Short-Term Repo by offering cheap financing, and it is now repeating the playbook with the longer dated ILTR. A BOE spokesperson said, "The ILTR is designed to allow firms to use a broad range of assets as collateral while protecting the Bank through robust risk management."

Level C includes pools of residential mortgages, loans to small businesses, and consumer credit - core assets for UK banks and building societies. Turning these harder-to-trade loans into central bank reserves can deliver a bigger liquidity boost than posting government bonds that already trade easily. Part of this year's pickup may reflect the wind-down of the Covid-era Term Funding Scheme that supported small and medium-sized firms; about £36 billion remains outstanding, mostly at major UK high street banks, and maturing loans may need replacing.

It is not free money. The BOE pays out less against riskier collateral by charging a higher spread over its benchmark rate: 15 basis points for Level C, 5 for Level B, and 3 for Level A. The main short-term repo bars these lower-grade assets, and the European Central Bank has raised the bar on its collateral rules. A number of traders and investors want the BOE to sweeten the terms of the long-term repo facility, or alternatively to run it every day.

Smart investors adapt to changing market mechanics to preserve long term gains. We're hosting our first ever investor livestream on 11/17 to show you how to use ChatGPT and Claude to invest like a pro, hosted by Briefs Finance CEO Jaspreet Singh. Save your seat.

SMBC Bank International's global market strategist, Hank Calenti, described the rising take-up as "a measure of success for the BOE as they want participants to use their repo facility more." He added, "With hedge funds getting more active in the UK gilt space and quantitative tightening, banks have found it advantageous to use both the STR and ILTR."

The risks experts are flagging

There is a trade-off when lower quality assets are in play. Because these loans are relatively illiquid and riskier, raising cash against them in private markets can be costly or even impossible, leaving the central bank among the only lenders prepared to accept them. Rising use of poorer collateral can also be read as a sign that banks want cash more urgently.

At the ICMA Centre within the University of Reading's Henley Business School, associate professor of finance Ivan Sangiorgi said, "The collateral could provide less protection precisely when the BOE needs it." He added, "The limited secondary-market liquidity of these assets could also complicate their valuation during periods of stress." He also noted that if banks can routinely fund such assets at the central bank, it may weaken the push to build other funding sources and make it harder for the BOE to tighten collateral standards in a crunch without worsening liquidity pressures. "For much of Level C collateral, there simply isn't a private repo market to turn to," he said. "The important question is therefore whether the Bank's risk-management framework remains sufficiently robust as Level C collateral is used increasingly."

What this means for your portfolio

This change follows a period in which the BOE reduced its gilt portfolio by nearly half, leaving it a touch under £500 billion, compared with a high reached roughly five years earlier, effectively draining liquidity from the system. Against that backdrop, more Level C collateral at the ILTR moves where liquidity sits and which assets banks can readily convert to reserves.

In plain English: market plumbing sets funding costs and how well trading holds up under stress. Watch how the BOE adjusts terms and frequency of its liquidity tools, and any tweaks to what it accepts as collateral. Those levers flow through to bank funding, bond pricing, and liquidity across assets your portfolio touches.

Knowing how new tools shift risk can help you make clearer investment choices. On 11/17, our CEO Jaspreet Singh goes live for our first ever investor livestream on how to use ChatGPT and Claude to invest like a pro. Register to join him.