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While the European Central Bank and the Federal Reserve are accused of becoming the dukes of moral hazard, the Bank of England’s response to credit market jitters has been that of an austere Victorian parent. Unlike the ECB and Fed it has refused to lend extra cash to the banking system through open market operations. And it has eschewed the Fed’s ruse of cutting the penalty rate that banks pay to use its emergency borrowing window.

Thus far the Bank’s smack of firm governance has worked. As in the US and eurozone, UK overnight rates have been drifting back down towards the Bank’s 5.75 per cent target rate, indicating that banks are no longer scared to lend to one another. Yet this relative calm was threatened again on Thursday when an initially anonymous bank said it was forced by a technical hitch to borrow £1.56bn from the Bank’s emergency window, paying the standard 100 basis point premium above the target rate.

On paper there is little to worry about. The facility is used often in more normal market conditions. Ten days ago, when Barclays spooked the markets by borrowing £314m, it turned out that the explanation was a back-office spat between Barclays and HSBC. On Thursday, it emerged that a technical hitch had again forced Barclays to be the source of the drawdown from the Bank’s facility.

But, ultimately, out in the trenches these reassurances feel rather hollow.
Thursday’s news knocked UK bank shares and sterling. And, quietly this week, overnight interbank borrowing rates in big jurisdictions have crept up again, with sterling and dollar rates in particular at a premium of more than 30bp to their respective target rates. This is rational: top-down estimates from the Fed among others suggest total subprime losses of $50bn-$100bn. So far the announced losses of institutions are nowhere near this, suggesting that someone, somewhere out there, could still be in serious trouble.

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