December 1, 2011 / 9:51 PM / 8 years ago

Ten days of secret planning to rescue markets

LONDON/FRANKFURT (Reuters) - Britain coordinated this week’s bold move by central banks to stave off a cash crunch in global markets, helping drive a plan that began to take shape around 10 days ago.

Bank of England governor Mervyn King presenting the Financial Stability Report in London, December 1, 2011. REUTERS/UK Pool via Reuters TV

Bank of England Governor Mervyn King said on Thursday he called the meetings that led to the decision by six of the world’s major central banks to cut dollar funding rates to keep money flowing through the world’s financial arteries.

“It was the result of conversations which I initiated as chairman of what used to be known as the G10 governors, now the economic consultative committee, among a limited number of central banks,” he told a news conference in London.

The decision by the U.S. Federal Reserve, European Central Bank and central banks of Japan, Canada, Britain and Switzerland to provide cheaper dollar funding for banks eased credit strains stemming from the euro zone debt crisis and provided a longed-for fillip to market sentiment.

Funding costs dropped for the first time since the latest phase of the euro zone crisis took hold in late July.

The Fed and ECB started seriously discussing Wednesday’s move around the middle of last week, one European banking source said, and the Fed’s policy panel held a videoconference on Monday at which it agreed to cut the interest rate on its dollar swap lines.

Another source said provisional agreement was reached in a teleconference at the start of last week, and that by the end of the week details had been agreed and the date of November 30 set for the announcement.

Several officials said there was no specific trigger for the action, with some specifically denying it was a move taken because a European bank was on the brink of collapse.

Instead, they characterized it as the culmination of weeks of worry as financial strains had built.

One official at a participating central bank noted that policymakers are in constant contact, and it was unclear whether any one official drove the action.

The ECB has been watching the creeping credit freeze with growing alarm for more than half a year but its interventions — lending banks in the euro zone half a trillion euros — have failed to defeat fears they could be sucked under by the region’s sovereign debt crisis.

Two years into Europe’s crisis, investors are fleeing the euro zone bond market, European banks are dumping government debt, deposits are draining from southern European banks and a looming recession is fueling doubts about the euro’s survival.

Fed officials have been quick to point out that the cheaper dollar swap lines, intended to ensure banks outside the United States have ready access to dollars, are not intended to bail out Europe — but to help shore up economic growth.

“There is not so much leverage out there in the market right now, so if we do see the banking system freezing up, you might not see much forced selling, but it would impact the global economy in a very big way,” said Kathleen Gaffney of Loomis Sayles, a part of Natixis Asset Management.


With dollar funding strains compounded by regulatory pressure, European banks have preferred to shore up balance sheets rather than fork out for dollar funding.

But most large banks also have dollar assets and liabilities. With interbank rates rising as concerns grow about the funding ability of counterparties, European banks have been effectively cut out of dollar markets. This has already prompted some European banks to dispose of U.S.-denominated assets — and sparked concerns that trade with the United States could be at risk.

Andrew Cole, investment director at Baring Asset Management, said the so-called TED spread — the difference between interest rates on interbank loans and short-term government bills — had been flashing warning signals.

“This is still a long way from the very high levels seen when Lehman Brothers failed, but has been moving steadily higher in recent months and is indicative of the concern about bank credit ratings, which has been impeding both inter-bank lending and lending in the wider economy,” Cole added.

The crisis has already prompted European banks to halt lending and start selling assets. But they are particularly keen to dispose of assets in U.S. dollars, where funding is most tight, seeing them pull back in areas like project finance, shipping finance, aviation and infrastructure.

For banks with big U.S. operations, or which tend to lend for projects denominated in dollars, like the French banks, this has been a particular problem.

Dollar funds have been made available via the ECB, but they are expensive and tapping the central bank carries stigma.

The funding crunch in Europe is far greater than simply a dollar issue, however, as banks in Europe’s crisis hotspots such as Greece have found themselves shut out of the interbank market needed to fund their day-to-day operations.

Even getting access to backstop funding options, such as ECB funding facilities, is becoming a problem as banks fret about running out of eligible securities they can use to tap these, or collateral. Banks are busy hoarding what securities they can to cash in at the ECB.

“This is Lehmans, take two. Cubed,” said Gaffney.

Additional reporting by Sarah White and Sinead Cruise in London; Writing by Kirstin Ridley and Tim Ahmann; Editing by Alexander Smith, Andrew Callus and Dan Grebler

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