The Bank of England could provide a significant boost to the UK’s government bond market and reduce annual public borrowing costs by more than £1bn if it reforms its leverage rules, according to major banks, although former regulators have warned such changes could increase financial stability risks.
The central bank is currently reviewing how its leverage framework operates after easing its main capital requirements in December. An update on the review is expected in the Bank of England’s Financial Stability Report.
Banks argue that the existing leverage rules discourage them from holding UK government bonds, known as gilts, limiting demand for public debt and contributing to higher government borrowing costs.
Barclays said any regulatory changes should apply only to unencumbered gilts, meaning government bonds that are freely available for sale and have not already been pledged as collateral in other financial transactions.
Lloyds estimates that reforming the leverage rules could increase bank demand for gilts by around £30bn, while reducing the government’s annual interest costs by at least £1bn.
According to Lloyds analysts, strengthening demand for government bonds has become a key priority for the UK Treasury, making regulatory changes that encourage banks to purchase more gilts an attractive policy option.
The analysts added that higher bank demand for government debt could help support future gilt issuance and ease pressure on the government’s financing requirements.
Britain has become increasingly reliant on overseas investors, including hedge funds, to finance government borrowing, a trend that has contributed to higher gilt yields in recent years.
UK banks also hold significantly less domestic government debt than many of their counterparts in the eurozone, highlighting the potential for regulatory changes to increase domestic demand for gilts while supporting the government’s long-term borrowing strategy.