Global Banks Freeze Lending As Solvency Fears Spread

Despite the best efforts of central banks yesterday, inter-bank lending slowed to a standstill as bankers balked at the growing turmoil in financial markets. The Fed, the ECB, and the Bank of Japan all made multi-billion dollar injections, but markets still froze: WSJ:

In one stark sign of waning confidence, the overnight London interbank offered rate, or Libor, a benchmark reflecting the rates at which banks lend to one another, more than doubled, in its sharpest spike on record. Longer-term Libor rates also rose sharply. If sustained, that move will push up payments on billions of dollars in mortgages and corporate loans that are linked to Libor.

The depth of the money-market problems became clear at lunchtime in London, when the British Bankers’ Association published Tuesday’s Libor borrowing costs. Every day, 16 banks report what it would cost them to borrow at certain maturities and currencies. Overnight dollar Libor soared to 6.4375% from 3.10625%, the largest jump on record. Three-month dollar Libor rose to 2.876% from 2.816%. Big global banks such as Bank of America, Credit Suisse Group, UBS, Royal Bank of Scotland Group PLC and others reported overnight borrowing costs of 6% or higher in dollars, compared with 3% just a day earlier.

The crisis has hit the point where the BoE is weighing an option which would allow officials to lend to struggling banks in secret, thereby avoiding exacerbating already poisonous sentiment:

In another sign of policy makers’ concerns about banks’ access to cash, the Bank of England is expected this week to propose a new permanent emergency-financing facility for troubled banks. The program will likely be designed to allow the central bank to help banks secretly, making short-term loans against collateral that would include hard-to-sell assets such as mortgage securities, say traders and analysts.

Another policy option that shows promise is also being discussed by lenders. The proposal would call for a massive pool of liquidity created by the world’s 10 largest banks which could be employed at any time to aid a struggling lender:

The banking industry is also working to create a separate, private borrowing pool, though details are still being ironed out. Under the guidance of the New York Fed, 10 of the world’s biggest banks have committed to chip in $7 billion each to the fund, dubbed the Primary Dealer Liquidity Facility. Any of the member banks can borrow up to one-third of the total fund.

[Unless they all need it at once…]

The structure seems intended largely as a confidence-building measure to assure jittery investors that major banks won’t run out of cash. Banks won’t actually fund the facility unless one of its 10 members needs to borrow from it.

And good luck hoping banks will honour the commitment then…

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