Central Banks Scramble To Avoid Credit Crunch II

Last week the US Federal Reserve together with the European Central Bank (ECB), the Bank of England (BoE) and the central banks of Canada, Japan and Switzerland took coordinated action to backstop troubled Eurozone banks. The move cuts the cost of emergency dollar loans to banks struggling to get funding such as those in France and Austria. The premium banks pay to borrow dollars overnight from central banks was cut in half to just 0.5%. These so-called dollar swap lines have also been extended by six months to 1 February 2013 and the six central banks also agreed to make other currencies available as needed.

This week the BoE has announced further measures to try to protect Britain’s banks against another credit crunch. The Extended Collateral Term Repo (ECTR) contingency plan unveiled on Tuesday will give lenders access to 30 day sterling loans if the current “exceptional stresses” on global financial markets spread to Britain’s interbank lending market.

As the charts below show the BoE is right to be worried. Both 1 month and 3 month LIBOR continue to rise.

Charts courtesy of Stockcharts.com

The London Interbank Offered Rate or LIBOR, as it’s known, is the interest rate banks charge each other for short-term loans, and because so many financial institutions track LIBOR, it is the benchmark for finance all around the world. Many commercial loan rates are also tied to LIBOR.

Although LIBOR remains well below the levels reached in 2009, it is the direction that is much more important than the actual nominal level, and the direction is telling as that the economy is under considerable duress. LIBOR essentially measures confidence between banks and therefore it has a tendency to spike when banks are unwilling to lend to one another for fear of not getting paid.


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