Bank of England study identifies drivers of securities lending price efficiency in UK markets
Securities lending remains a core part of modern financial market plumbing, supporting short selling, market making and liquidity management across collateral types. New Bank of England research examines how returns are priced when the same security is lent against cash or securities collateral, highlighting the roles of risk, illiquidity and dealer balance-sheet constraints.
Highlights
- Bank of England study finds that returns from lending the same security vary based on whether collateral is cash or other securities.
- The model identifies security risk, illiquidity, and dealer balance-sheet constraints as drivers of a 'return wedge' between collateral structures.
- The return wedge widens with higher risk, illiquidity, dealer constraints, and collateral reusability, but narrows as cross-segment participation increases, improving pricing efficiency.
Research findings on lending returns
As reported by the Bank of England, transaction-level data show that returns from lending the same security differ depending on whether the trade is backed by cash or by securities collateral.The research develops a model in which lending returns compensate market participants for security risk, illiquidity and the use of scarce dealer balance-sheet capacity. It also defines a return wedge between the two market segments, offering a framework for comparing pricing across collateral structures.
Implications for UK market functioning
Consistent with the model, the return wedge widens as risk, illiquidity, dealer constraints and collateral reusability increase. It narrows as participation across both market segments rises, suggesting broader market access can improve pricing efficiency.The findings add to understanding of how securities lending markets function in the UK financial system. For market participants and regulators, the analysis points to balance-sheet capacity and collateral conditions as important factors shaping costs, liquidity and the transmission of stress across market segments.
Our earlier article on Bank of England Deputy Governor Sarah Breeden’s comments on the UK economy’s resilience to the energy price shock noted that the impact on activity was less severe than initially expected. We also highlighted that inflation and market volatility remain key risks, keeping policymakers focused on monitoring financial conditions and adapting policy to safeguard UK stability.
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