The Bank of England made on Thursday its biggest concession yet to banks caught up in the credit crisis, giving them greater flexibility on how much cash they can borrow without penalty to manage daily cashflow.
Britain's central bank -- which has has taken a largely hands-off stance on the crisis engulfing world credit markets-- allowed banks to raise their reserves by 4.4 billion pounds, as flagged last week.
More significantly, from now on banks can let their reserves target at the central bank fluctuate by 37.5 percent on either side instead of the normal one percent band.
Interbank lending rates came down after the announcement, having shot up in recent weeks as financial institutions were reluctant to lend.
It looks like the BoE are giving banks a little bit more flexibility to reflect market conditions, said Russell Silberstone, head of the interest rate team at Investec Asset Management.
At the start of each month, banks tell the BoE what they want to hold in reserves at the central bank which should cover them for the biggest difference between the amount of money they receive and what they pay out. Normally, banks are obliged to hold one percent above or below that balance when averaged over the month or else they get penalised. But they will now have a much bigger buffer for any unforeseen cash needs.
Marc Ostwald, strategist at Insinger de Beaufort, said the widening of the target bands was a significant development that meant banks would be under less pressure to use the Bank's penalty lending facility.
Banks have so far been reluctant to use this facility, partly because of the expense -- they need to pay one percentage point over the base rate for the privilege -- and partly because of the stigma attached.
While such borrowing is supposed to be anonymous, intense media pressure forced Barclays Plc to own up to using the facility twice in August and to reassure markets that it was flush with cash.
BoE Governor Mervyn King made clear in a letter to parliament's Treasury Committee on Wednesday that raising banks' reserve targets was designed to lower overnight rates but not to ease the logjam in term lending rates, which he sees as a problem for the market to sort out.
King said the extra reserves had been necessary because there were grounds for suspecting banks may have underestimated their demand for reserves at the start of the current maintenance period.
(Additional reporting by Matt Falloon and Sumeet Desai)