...excluding from the calculation of the risk premium payable to taxpayers the great surge in the perceived riskiness of banks that took place in September and October.In effect, the Treasury has converted the Credit Guarantee Scheme from an insurance policy, which was designed to provide comfort to markets that banks wouldn't collapse for want of access to funding, into a new and substantial source of finance for banks, to replace the funds that have disappeared with the de facto closure of wholesale markets.
- The short/long risk is transferred to the government - which in theory may have its own challenges in raising long-term debt. But in extremis, the government can print money to finance this - it should never have to default (the UK government is in the fortunate position of both borrowing and lending in pounds, at least for now).
- It creates an increase in the amount of short-term money available in the economy - wholesale lenders which would previously have lent to banks can now lend in the corporate or consumer markets instead. In theory this is a distortion to the normal structure of the money markets but with everything else that's happening, it just cancels out a distortion that's already happening.