Central banks intervene to prevent borrowing crisis

The US Federal Reserve, the European Central Bank (ECB), the Bank of England and the central banks of Canada, Japan and Switzerland are making unlimited quantities of dollars available to commercial banks in the eurozone.

These banks are finding it expensive to borrow from financial institutions outside the eurozone and the co-ordinated action is designed to bring down their costs. Their intervention led to stock market rallies and a rise in the euro.

The development follows a warning from European Commissioner Olli Rehn that there are just 10 days left to save the euro, which prompted Chancellor George Osborne to say that Britain would “find it difficult to avoid a recession” if economic growth in Europe seized up.

Paul Kavanagh, a partner at Killik and Co stockbrokers, told Channel 4 News: “It is an indication of how stressed the banking system was becoming over the past few days and the need for urgent action. I expect this to be followed up by further pressure on European leaders to do more.”

It is an indication of how stressed the banking system was becoming. Paul Kavanagh, Killik and Co

The latest move by the central banks almost halves the cost to commercial banks of borrowing dollars from them. In September, five central banks announced that instead of lending dollars to commercial banks for a week, they would extend this period to three months. The development on Wednesday is a sign that the world’s major economies recognise how difficult it has become for banks to borrow money at rates they can afford.

‘Ease strains’

The Bank of England said in a statement: “The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity.”

Silvio Peruzzo, an economist at Royal Bank of Scotland, said: “This is something that is very welcome. This will not solve all deep-based funding problems which are due to the sovereign debt crisis. But there is an issue with dollar liquidity, especially with foreign currency, and this measure addresses that.”

Mr Peruzzo said he expected the ECB to announce further measures at its next policy meeting in a week’s time, adding: ” The ECB currently accepts individual bank loans under certain criteria, but it does not appear that banks have used this facility in any meaningful way. Providing incentives for banks to post loans at the ECB would potentially open up a major avenue for refinancing and could help alleviate the credit crunch risks building in the system.”

Bailouts

Eurozone banks are feeling the heat because they own government debt in the form of gilts. Two indebted EU countries, Ireland and Portugal, have already been bailed out by the European Financial Stability Facility, Greece is receiving assistance and there are fears that Spain and Italy will need help because of the increasingly higher interest rates they are being charged on their borrowing.

The British government, which is also borrowing heavily, is being charged far less. Mr Osborne has said this is a sign that the markets have faith in the goverment’s deficit reduction programme.