April 21 (Bloomberg) -- The Bank of England offered to swap government bonds for mortgage securities to kick-start bank lending, with Governor Mervyn King pledging to meet demand even if it exceeds an estimate of 50 billion pounds ($100 billion.)

``There is no arbitrary limit on this so it could well go higher,'' King told reporters in London today. He said the plan aims to restore confidence to the banking system and the most important aspect is that ``everyone needs to know this is there for them to access as needed.''

The measures, backed by Prime Minister Gordon Brown's government, mimic a swap of $200 billion of securities by the U.S. Federal Reserve last month as central banks around the world struggle to prop up financial markets. A surge in borrowing costs prompted U.K. banks to withdraw their best mortgage offers, threatening to exacerbate the worst housing downturn since 1992.

``This package may help ease money-market strains, and provide a welcome route to liquidity for some particular banks and building societies that otherwise may face extreme difficulties in obtaining funds,'' said Michael Saunders, chief western European economist at Citigroup Inc.

Financial institutions will retain responsibility for losses from the assets they loan to the Bank of England. The swaps will be for a period of one year, renewable for up to three years. Only assets existing at the end of 2007 can be used in the swap.

The Bank of England won't announce how much money has been tapped until the borrowing window closes in six months.

Bank Losses

The swap is double the value of loans King extended in September to prop up Northern Rock Plc. The government nationalized the mortgage lender in February, the first U.K. bank to fall victim to the credit freeze. That stemmed from the collapse of the U.S. subprime market, which has now cost more than $288 billion in bank writedowns and credit losses.

U.K. government bonds rose and the pound fell after the announcement. The pound declined to $1.9850 at 2:44 p.m. in London, from $1.9979 at the end of last week, when it climbed 1.5 percent. Gilts rose, depressing the yield on two-year notes by 6 basis points to 4.27 percent. The central bank cut its key rate three times since December to 5 percent.

Assistance will come at a price. Banks will have to pay a borrowing fee to participate in the plan and the value of the securities they receive will be less than that of the mortgage- backed bonds they hand over to the Bank of England.

`Quite Punitive'

``The Bank of England's actions do seem to be quite punitive,'' said James Nixon, a director of Societe Generale SA in London. ``The sense yet again from the Bank of England is that it will provide an absolute backstop to the financial system, but won't make any effort to ease the market's liquidity.''

The fee will represent the gap between the cost of borrowing three-month funds in the market and the cost of three-month gilt repurchases, currently 1.04 percent. So-called ``haircuts'' on top-rated mortgage-backed securities will range between 12 percent and 22 percent. A 22 percent discount means a bank gets 78 pounds of gilts for 100 pounds of the security submitted.

The plan is a change of approach by the Bank of England. King initially refused to help financial institutions before cutting interest rates and offering them emergency funds with looser collateral restrictions. The European Central Bank, the first central bank to react to the credit crisis in August, has extended the maturity of money auctions to help cash-strapped institutions.

The U.S. Federal Reserve last month made up to $200 billion available to banks in return for debt including mortgage-backed securities.

`Enough Liquidity'

``We will make sure there is enough liquidity in the economy to make sure people can buy their own houses,'' Brown said in a speech today in Inverness, Scotland.

``The collateral swap arrangement is an innovative and unique policy response,'' the British Bankers' Association said in a statement today.

European banks sold 25.7 billion euros ($41 billion) of mortgage-backed securities so far this year, down from 91.2 billion euros in the same period last year, according to Deutsche Bank AG.

Investors are demanding yields as high as 155 basis points above the interbank lending rate to hold the top-rated bonds backed by U.K. mortgages, up from 65 basis points at the end of last year, according to Dresdner Kleinwort on Friday. Bonds backed by U.K. credit cards are trading at about 205 basis points, up from 80 basis points at the end of last year.

`Right Thing to Do'

``If we didn't do this there was a risk that the situation would have become worse,'' Chancellor of the Exchequer Alistair Darling said today in an interview with Sky News. ``This is the right thing to do to stabilize the situation. At the moment there is little or no market for assets backed by mortgages.''

Darling will speak to Parliament in London about the decision at 3:30 p.m. today. Darling will meet members of the U.K. Council of Mortgage Lenders tomorrow, aiming to agree measures to help borrowers who fall into arrears on loans.

The risk is that a slide in house prices worsens, undermining support for Brown's government. Mortgage lenders including HBOS Plc and Lloyds TSB Group Plc have raised the cost of loans, even after three quarter-point rate cuts by the Bank of England.

House prices dropped 2.5 percent in March from a month earlier, the biggest drop since 1992, HBOS, the country's largest mortgage lender, said April 8. Brown's approval rating dropped faster than for any U.K. leader on record as support for the opposition rose to the highest in 16 years, a poll published on April 13 showed.

Housing Market

``It might just free up a bit more liquidity,'' Simon Rubinsohn, an economist at the Royal Institution of Chartered Surveyors, said in an interview on Bloomberg Television. ``It's not going to turn things round in the housing market.''

The banks will be able to enter into a swap at any time over the next six months. Assets that can be used must have the top AAA ratings. They will include mortgage debt and credit card debt. ``Raw mortgages'' and derivatives are excluded.

``The length of these transactions will provide banks with the certainty about liquidity that is needed to boost confidence,'' the bank said in a statement.

The central bank's move allows financial institutions to add government bonds to their inventory of liquid assets and make it easier for them to both raise cash and lend, especially to consumers seeking home loans. In return, the government will hold the riskier mortgage-backed assets as security.

To date, the Bank of England has widened its collateral requirements just for three-month lending. It accepts only top- rated government securities at its weekly auctions.

The bank said the public is exposed to a loss only if a lender participating in the program defaults and the assets they have placed with the central bank are insufficient to cover the value of the Treasury bills in the swap. That's why the bank is asking for collateral of greater value than the bills it lends.

To contact the reporters on this story: Jennifer Ryan in London at Jryan13@bloomberg.net; Brian Swint in London at bswint@bloomberg.net.

Last Updated: April 21, 2008 10:13 EDT