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Central banks combat credit squeeze

The US Federal Reserve and four other central banks announced a joint initiative on Wednesday to ease a global credit squeeze by pumping money into the global banking system with a new system of loan auctions.

The joint effort with the Bank of Canada, Bank of England, European Central Bank (ECB) and the Swiss National Bank is "designed to address elevated pressures in short-term funding markets," the US central bank said in a statement.

The Fed also announced plans for a swap of credit lines with the ECB and Swiss central bank to help provide dollars to the banking system.

The move comes amid concerns about a widening credit crunch in which commercial banks are curbing lending even to other banks, raising fears of a retrenchment that could crimp global economic growth.

AUCTION SYSTEM

The effort creates a temporary short-term auction system to allow commercial banks another avenue to obtain funding. The first auction of US$20 billion will be held on Monday by the Fed with an additional US$20 billion made available on Dec. 20.

The Fed said the effort offered a new way to inject money into the banking system following a series of steps since the credit crisis erupted in August.

The actions "could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress," the Fed said.

Brian Bethune, economist at Global Insight, said that he was "surprised that the central banks waited so long" to implement the plan of action.

He said the plan "was designed to stave off continued tightening of credit and liquidity conditions in the worldwide interbank markets."

One major concern for markets had been a sharp rise in the rate of LIBOR -- the London interbank rate used for much interbank lending. The rise suggested banks were curbing lending and were short of cash needed for these loans.

Bethune said the upward pressure on LIBOR rates "is problematic for the sustainability of the economic expansion, since the LIBOR interbank rate is widely used as a benchmark for floating rate borrowing, including adjustable rate mortgages and short-term corporate and commercial borrowing lines."

Robert Brusca at FAO Economics said the plan appears aimed at addressing the squeeze facing European banks with dollar-based short-term loans to companies known as commercial paper.

"It's an attempt to get dollar liquidity to European banks that were caught short when the US commercial paper market collapsed," Brusca said.

"This should help [ease the credit crunch] if the nature of the problem in Europe is a shortage of dollars," he said.

CURRENCY SWAP LINES

The Fed also announced temporary currency swap lines with the European Central Bank and the Swiss National Bank. These will provide up to US$20 billion to the ECB and US$4 billion to the Swiss central bank for up to six months.

Meanwhile, the Bank of Japan sees no need to join the plan by other central banks to ease the credit squeeze because its domestic financial system is solid, a spokesman said yesterday.

The Bank of Japan welcomed the plan but said there was no need for similar action in Asia's largest economy.

"We are keeping in touch with the other central banks. We simply see no need to take special measures for the year-end as markets are functioning well through daily money market operations," the spokesman said.

Earlier this year the Bank of Japan pumped billions of dollars into the domestic financial system in tandem with other major central banks to calm markets after the subprime loan crisis erupted in late July.

But the bank later moved to siphon off excess funds amid ample liquidity.
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