THE Bank of England is locked in talks with seven British building societies to renegotiate crisis funding measures introduced at the height of the credit crunch.

A slew of credit-rating downgrades for building societies last week threatens to breach the terms of the government’s Special Liquidity Scheme and force the societies to hand back cash to the Bank of England.

Such a move would reduce the amount of new lending they could make, dealing a blow to Whitehall plans to kick-start the housing market.

Chelsea, Yorkshire, Skipton, Coventry, Newcastle, Norwich & Peterborough and Principality are the societies affected. All have recently passed stress tests imposed by the Financial Services Authority (FSA) and are not considered in danger of collapse. Nonetheless, they will now be charged more to use the emergency funding.

Chelsea has already breached the terms of the scheme, and could have to pay back some of the cash it has received from the Bank. Alternatively, it may have to hand over more of its mortgages to the Bank as collateral.

The other six societies have 30 days to negotiate a deal with the ratings agency Moody’s and the regulators.

Standard Life Bank, the banking subsidiary of the listed life assurer, is also caught up on the fringes of the affair.

There are 52 building societies in Britain, which have lent almost £400 billion and hold more than £200 billion of customers’ savings.

The funding talks follow the collapse last month of Dunfermline building society, which has raised questions about the FSA’s regulation of the sector during the boom years. Lord Turner, the FSA chairman, sent a nine-page letter to chancellor Alistair Darling on Friday defending the regulator’s track record in allowing the societies to make riskier loans.

Talks between the Bank and the seven societies began late last week. The problem relates to covered bonds – financial instruments used by the societies to parcel up their mortgages and sell them on to third-party financial investors.

The societies lodged these bonds with the Bank last year. However, under the terms of the scheme, the Bank can only accept bonds with two AAA credit ratings. Moody’s downgrades for the sector last week have had a knock-on effect on the ratings of these bonds.

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