Banks remain laden with dubious debts they accumulated
Reuters 16 February 2009
(LONDON) Bank-to-bank lending, the lifeblood of the financial system, has made only a partial recovery from a seizure that paralysed money markets and still lacks the strength required to nurse economies back to health. Massive cash injections by central banks have relieved the worst of the symptoms, while swingeing cuts in official interest rates to record lows have slashed actual bank-to-bank lending rates.
But banks are still charging each other an unhealthily wide premium over a near risk-free benchmark rate that is linked to market expectations of central bank interest rates. This may not be surprising given that banks are still laden with dubious debt accumulated over years when credit and housing market bubbles inflated each other.
Yet increasing and cheapening the flow of funds between banks will be vital to ensuring that banks in turn give firms and consumers the credit they need to stop a global recession turning into the next Great Depression.
‘It’s good to see more stable money markets, but the very fact that these risk premia remain still at relatively high levels indicate that we’re far from out of the woods yet,’ said Don Smith, economist at ICAP in London.
The risk premium that Mr. Smith and others in financial markets are watching so closely is measured against Libor, the London interbank offered rates.
Libor became much more widely talked about at the height of the crisis last year as a gauge of how worried banks were about the risks that they or their peers might collapse.
In the weeks after the collapse of Lehman Brothers in September 2008, the Libor rate for borrowing dollar funds over three months rocketed to 4.8 per cent from around 2.8 per cent. This rate has since subsided to around 1.2 per cent, having reached nearly 1.0 per cent last month - the lowest since 2003 - but its downtrend is mainly due to successive Federal Reserve rate cuts which have left its key rate at 0-0.25 per cent.
Meanwhile, the premium that Libor rates trade over near risk-free Overnight Index Swap rates (OIS) - the Libor/OIS spread - has also eased from peaks seen in October. But it remains above both pre-Lehman collapse levels and those seen before the credit crisis broke late in 2007.
Former Federal Reserve chief Alan Greenspan said last year that the market would know the crisis was ending when the three-month dollar Libor/OIS gap narrowed to about 50 basis points.
The three-month dollar Libor/OIS spread blew out to around 360 basis points from 80 basis points in October, but is now near 100 basis points. It consistently traded at about 10 basis points before the credit crisis.
Mr. Greenspan’s target of 50 basis points is unlikely to be seen until at least March 2010, according to forward market prices. These see the spread at around 83 basis points by December and about 65 basis points by March 2010, data from ICAP showed.
Analysts polled by Reuters mostly expect the financial crisis to last at least another six months to a year, although some say it’ll last one to two years or possibly more.
Admittedly, the money market has shown some stability as governments have tried to shore up the banking industry - by partially or fully taking over some banks, guaranteeing their debt issues and seeking to purge toxic assets from their books.
Also, central banks have become lenders of first resort, pumping massive amounts of cash into banks and coordinating with each other to meet global demand for US dollars.
Just this week, US Treasury Secretary Timothy Geithner unveiled another bank rescue plan that would use US$2 trillion to mop up bad assets and restore credit.
The normal functioning of the money markets was seen as a precondition to staving off a protracted downturn, but now banks want to see more promising economic conditions before they lend out money without demanding a hefty premium.
In a grim assessment of the global economy, the International Monetary Fund last month said growth is set to slow to a virtual standstill, slashing its 2009 forecast to a slight 0.5 per cent, the weakest since World War II.
‘We really need the economic environment to stabilise but that’s difficult because the financial sector is having to deal with a lot of uncertainty about the degree of exposure towards the mortgage-backed securities and in addition it’s being threatened with a very severe economic downturn,’ Mr. Smith said.
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Money markets still not ready to nurture economy
Banks remain laden with dubious debts they accumulated
Reuters
16 February 2009
(LONDON) Bank-to-bank lending, the lifeblood of the financial system, has made only a partial recovery from a seizure that paralysed money markets and still lacks the strength required to nurse economies back to health. Massive cash injections by central banks have relieved the worst of the symptoms, while swingeing cuts in official interest rates to record lows have slashed actual bank-to-bank lending rates.
But banks are still charging each other an unhealthily wide premium over a near risk-free benchmark rate that is linked to market expectations of central bank interest rates. This may not be surprising given that banks are still laden with dubious debt accumulated over years when credit and housing market bubbles inflated each other.
Yet increasing and cheapening the flow of funds between banks will be vital to ensuring that banks in turn give firms and consumers the credit they need to stop a global recession turning into the next Great Depression.
‘It’s good to see more stable money markets, but the very fact that these risk premia remain still at relatively high levels indicate that we’re far from out of the woods yet,’ said Don Smith, economist at ICAP in London.
The risk premium that Mr. Smith and others in financial markets are watching so closely is measured against Libor, the London interbank offered rates.
Libor became much more widely talked about at the height of the crisis last year as a gauge of how worried banks were about the risks that they or their peers might collapse.
In the weeks after the collapse of Lehman Brothers in September 2008, the Libor rate for borrowing dollar funds over three months rocketed to 4.8 per cent from around 2.8 per cent. This rate has since subsided to around 1.2 per cent, having reached nearly 1.0 per cent last month - the lowest since 2003 - but its downtrend is mainly due to successive Federal Reserve rate cuts which have left its key rate at 0-0.25 per cent.
Meanwhile, the premium that Libor rates trade over near risk-free Overnight Index Swap rates (OIS) - the Libor/OIS spread - has also eased from peaks seen in October. But it remains above both pre-Lehman collapse levels and those seen before the credit crisis broke late in 2007.
Former Federal Reserve chief Alan Greenspan said last year that the market would know the crisis was ending when the three-month dollar Libor/OIS gap narrowed to about 50 basis points.
The three-month dollar Libor/OIS spread blew out to around 360 basis points from 80 basis points in October, but is now near 100 basis points. It consistently traded at about 10 basis points before the credit crisis.
Mr. Greenspan’s target of 50 basis points is unlikely to be seen until at least March 2010, according to forward market prices. These see the spread at around 83 basis points by December and about 65 basis points by March 2010, data from ICAP showed.
Analysts polled by Reuters mostly expect the financial crisis to last at least another six months to a year, although some say it’ll last one to two years or possibly more.
Admittedly, the money market has shown some stability as governments have tried to shore up the banking industry - by partially or fully taking over some banks, guaranteeing their debt issues and seeking to purge toxic assets from their books.
Also, central banks have become lenders of first resort, pumping massive amounts of cash into banks and coordinating with each other to meet global demand for US dollars.
Just this week, US Treasury Secretary Timothy Geithner unveiled another bank rescue plan that would use US$2 trillion to mop up bad assets and restore credit.
The normal functioning of the money markets was seen as a precondition to staving off a protracted downturn, but now banks want to see more promising economic conditions before they lend out money without demanding a hefty premium.
In a grim assessment of the global economy, the International Monetary Fund last month said growth is set to slow to a virtual standstill, slashing its 2009 forecast to a slight 0.5 per cent, the weakest since World War II.
‘We really need the economic environment to stabilise but that’s difficult because the financial sector is having to deal with a lot of uncertainty about the degree of exposure towards the mortgage-backed securities and in addition it’s being threatened with a very severe economic downturn,’ Mr. Smith said.
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