Central Banks May Seek More `Bang' for Buck as Markets Seize Up
By Simon Kennedy
Sept. 17 (Bloomberg) -- Central bankers may need to take a more global approach to steadying financial markets with actions that include making it easier for banks to borrow across borders.
Credit remained scarce today even after central banks added more than $200 billion in extra funds this week. Banks hoarded money, concerned that more financial institutions will follow Lehman Brothers Holdings Inc. into bankruptcy. The cost of borrowing in dollars for three months jumped the most since 1999 with the crisis spreading abroad as U.K. mortgage lender HBOS Plc slumped and Russia poured money into its banks.
The remedy may be what Bank of Italy Governor Mario Draghi yesterday called a more ``internationally coordinated effort.'' To ease market tensions and stop them from plunging the world into recession, central banks may need to accept additional collateral denominated in foreign currencies and lend more to banks abroad. The Federal Reserve might also need to dispatch dollars around the world more quickly.
``The central banks may get more bang for their buck by working together more instead of the patchwork approach,'' said David Hensley, an economist at JPMorgan Chase & Co. ``If they did something in a more unified way, it would carry more weight in markets.''
So far this week central banks have worked unilaterally to address liquidity shortages. Russian policy makers today cut the reserve requirements for banks as the country faced its worst financial crisis since the government defaulted on domestic debt a decade ago.
Special Program
The Bank of England extended a special liquidity program set to expire next month, and the Bank of Japan injected another 3 trillion yen into its banking system. Such efforts followed offers of additional funds earlier in the week by central banks including the Fed and the European Central Bank.
``Central banks are going to be forced to consider all options,'' said Neil Mackinnon, chief economist at ECU Plc in London.
The collapse of Lehman and the U.S. government rescue of American International Group Inc. pushed the cost of borrowing U.S. currency overnight to 6.44 percent yesterday, the highest since 2001. The cost of borrowing dollars for three months surged 19 basis points to 3.06 percent today, while the gap between the amount that banks and the U.S. Treasury pay to borrow at three months was the widest since the October 1987 stock-market crash.
Foreign Currency
Bank of Japan Governor Masaaki Shirakawa told reporters that central banks are discussing the possibility of making it easier to accept collateral for loans denominated in foreign currency. A shortage of dollars is among the most pressing problems in international financial markets at the moment, and such a policy would enable banks to use high-quality collateral priced in euros or yen, or held abroad, to obtain dollars from the Fed.
Shane Oliver, head of investment strategy at AMP Capital Investors in Sydney, said central banks ``need to be relaxing their collateral requirements'' even more. The Fed said in the wake of Lehman's fall that it will allow securities firms to use equities as loan collateral.
``We're moving toward more money for more parties for more collateral,'' said Robert Barrie, an economist at Credit Suisse Group in London.
Permanent Swap Lines
Another recommendation -- in an April report by the Financial Stability Forum, an international group of regulators Draghi chairs -- is to make permanent the temporary swap lines that allow central banks to transmit currency to their neediest counterparts. The Fed introduced an ad-hoc swap line with the ECB in December and boosted it in July, authorizing it through January 2009.
Commercial banks may also need the ability to borrow from central banks in other countries, said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey. Banks currently can't borrow dollars from the Fed unless they have a U.S. branch.
``The fact that global banks have such large portfolios yet no direct access to central bank funding outside the U.S. has been a crucial weakness,'' Crandall said.
A prolonged crisis may mean central banks will eventually start purchasing assets outright, said Natacha Valla, an economist at Goldman Sachs Group Inc. who was formerly at the ECB. ``There is still a long way to go before they'd need to consider this,'' she said.
Unwinding Debt
Julian Jessop, chief international economist at Capital Economics Ltd. in London, says central banks may be wary of providing greater liquidity for fear it will stop financial institutions from unwinding their debt and consolidating. The ECB said Sept. 4 it will make it harder for banks to exploit its lending rules.
``Central banks may actually want to keep up pressure for banks to sort out their own problems and so step back,'' Jessop said.
Since the credit squeeze began in August 2007, many central banks have sought to keep apart the need to soothe markets and to combat inflation. They have argued that interest rates are a blunt tool for helping markets and that price pressures prevent them from cutting rates. The test of what Morgan Stanley economists call a ``separation principle'' may come if the spasms in the markets threaten to derail growth.
``The separation is getting thinner by the day, and at some point the central banks may be forced to give it up,'' said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Group Plc.
To contact the reporters on this story: Simon Kennedy in Paris at [email protected]
Last Updated: September 17, 2008 15:32 EDT
By Simon Kennedy
Sept. 17 (Bloomberg) -- Central bankers may need to take a more global approach to steadying financial markets with actions that include making it easier for banks to borrow across borders.
Credit remained scarce today even after central banks added more than $200 billion in extra funds this week. Banks hoarded money, concerned that more financial institutions will follow Lehman Brothers Holdings Inc. into bankruptcy. The cost of borrowing in dollars for three months jumped the most since 1999 with the crisis spreading abroad as U.K. mortgage lender HBOS Plc slumped and Russia poured money into its banks.
The remedy may be what Bank of Italy Governor Mario Draghi yesterday called a more ``internationally coordinated effort.'' To ease market tensions and stop them from plunging the world into recession, central banks may need to accept additional collateral denominated in foreign currencies and lend more to banks abroad. The Federal Reserve might also need to dispatch dollars around the world more quickly.
``The central banks may get more bang for their buck by working together more instead of the patchwork approach,'' said David Hensley, an economist at JPMorgan Chase & Co. ``If they did something in a more unified way, it would carry more weight in markets.''
So far this week central banks have worked unilaterally to address liquidity shortages. Russian policy makers today cut the reserve requirements for banks as the country faced its worst financial crisis since the government defaulted on domestic debt a decade ago.
Special Program
The Bank of England extended a special liquidity program set to expire next month, and the Bank of Japan injected another 3 trillion yen into its banking system. Such efforts followed offers of additional funds earlier in the week by central banks including the Fed and the European Central Bank.
``Central banks are going to be forced to consider all options,'' said Neil Mackinnon, chief economist at ECU Plc in London.
The collapse of Lehman and the U.S. government rescue of American International Group Inc. pushed the cost of borrowing U.S. currency overnight to 6.44 percent yesterday, the highest since 2001. The cost of borrowing dollars for three months surged 19 basis points to 3.06 percent today, while the gap between the amount that banks and the U.S. Treasury pay to borrow at three months was the widest since the October 1987 stock-market crash.
Foreign Currency
Bank of Japan Governor Masaaki Shirakawa told reporters that central banks are discussing the possibility of making it easier to accept collateral for loans denominated in foreign currency. A shortage of dollars is among the most pressing problems in international financial markets at the moment, and such a policy would enable banks to use high-quality collateral priced in euros or yen, or held abroad, to obtain dollars from the Fed.
Shane Oliver, head of investment strategy at AMP Capital Investors in Sydney, said central banks ``need to be relaxing their collateral requirements'' even more. The Fed said in the wake of Lehman's fall that it will allow securities firms to use equities as loan collateral.
``We're moving toward more money for more parties for more collateral,'' said Robert Barrie, an economist at Credit Suisse Group in London.
Permanent Swap Lines
Another recommendation -- in an April report by the Financial Stability Forum, an international group of regulators Draghi chairs -- is to make permanent the temporary swap lines that allow central banks to transmit currency to their neediest counterparts. The Fed introduced an ad-hoc swap line with the ECB in December and boosted it in July, authorizing it through January 2009.
Commercial banks may also need the ability to borrow from central banks in other countries, said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey. Banks currently can't borrow dollars from the Fed unless they have a U.S. branch.
``The fact that global banks have such large portfolios yet no direct access to central bank funding outside the U.S. has been a crucial weakness,'' Crandall said.
A prolonged crisis may mean central banks will eventually start purchasing assets outright, said Natacha Valla, an economist at Goldman Sachs Group Inc. who was formerly at the ECB. ``There is still a long way to go before they'd need to consider this,'' she said.
Unwinding Debt
Julian Jessop, chief international economist at Capital Economics Ltd. in London, says central banks may be wary of providing greater liquidity for fear it will stop financial institutions from unwinding their debt and consolidating. The ECB said Sept. 4 it will make it harder for banks to exploit its lending rules.
``Central banks may actually want to keep up pressure for banks to sort out their own problems and so step back,'' Jessop said.
Since the credit squeeze began in August 2007, many central banks have sought to keep apart the need to soothe markets and to combat inflation. They have argued that interest rates are a blunt tool for helping markets and that price pressures prevent them from cutting rates. The test of what Morgan Stanley economists call a ``separation principle'' may come if the spasms in the markets threaten to derail growth.
``The separation is getting thinner by the day, and at some point the central banks may be forced to give it up,'' said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Group Plc.
To contact the reporters on this story: Simon Kennedy in Paris at [email protected]
Last Updated: September 17, 2008 15:32 EDT
