Banks scramble for cash as Fed's Kohn notes risks

By Ruth Pitchford

LONDON (Reuters) - Banks scrambled for cash on Wednesday to cover their funding needs as a year-end credit squeeze intensified and the European Central Bank stepped in to lend three-month funds at its highest rate in 6-1/2 years.

The ECB lent banks 50 billion euros ($73.7 billion) -- less than half the amount they bid for -- to tide them over the New Year period. The banks paid an average 4.70 percent, way over the ECB's policy rate of 4.0 percent and the highest since April 2001, when its policy rate was 4.75 percent.

It still wasn't enough. "We didn't see any effect on markets after the (auction result) announcement. The amount they're needing is a lot more than the ECB is allotting," said a euro zone money market trader.

The lending rates banks charge each other have surged far above official benchmark rates as banks hoard cash for fear of exposure to the high-risk debt that proliferated during a long-running credit boom. That has intensified the usual worries about tight liquidity over the New Year period.

A U.S. central banker said the global crunch that halted the boom in August might hit households and businesses harder than previously thought as banks make it harder and more expensive for them to borrow.

Federal Reserve Vice Chairman Donald Kohn told the Council on Foreign Relations in New York on Wednesday that markets had partly reversed the recovery they had begun in late September and October.

"Should the elevated turbulence persist it would increase the possibility of further tightening in financial conditions for households and businesses," Kohn said.

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