The world's central banks launched an unprecedented joint effort to inject more than $100bn (£48.9bn) to help to thaw a lending freeze that is threatening the stability of the financial system.
The US Federal Reserve, the Bank of England and the European Central Bank, with their counterparts in Switzerland and Canada, unveiled a raft of new ways to encourage financial institutions to borrow from their central banks.
The announcement yesterday sent stock markets up, helping to reassure investors who had fretted a day earlier that the Federal Reserve was not taking sufficiently robust action to tackle the credit crisis.
Central bankers decided behind the scenes of the Group of 20 summit in South Africa last month to begin work on a dramatic, co-ordinated, plan to shore up confidence. Almost four months of piecemeal efforts to restore confidence and liquidity to the credit markets – including interest rate cuts and offers of extra central bank lending – had proved less effective than expected.
As banks and the money market funds that grease the financial system have become more reluctant to lend to each other, businesses have found it harder and more expensive to borrow cash to fund their operations. It was just such a situation in August that triggered the Northern Rock crisis, and the situation in the credit markets has deteriorated again in the past month.
Central bankers have been searching for ways to encourage institutions to come to them for funds instead.
Running through the package of measures announced yesterday is a message that there should be no stigma attached to borrowing from the central banks. The Bank of England has acknowledged that its previously hard-line stance against lending gave the impression it was only willing to help out institutions that had got themselves into dire straits. The Governor Mervyn King, who faced criticism over the Northern Rock debacle, insisted on international co-ordination to signal that central banks were willing to act together to boost confidence.
The measures are also expected to have the effect of reducing interest rates for borrowing from the banks.
The Federal Reserve unveiled a plan to offer at least $40bn, and probably much more, by way of an auction of fixed-term lending. By making it an auction process, it hopes to attract bidders who would be reluctant to borrow from the Fed's "discount window", where emergency funds are being made available, but at an interest rate that is higher than the main Fed funds rate.
The Bank of England said it will make available £10bn of key three-month funding in December and January. That will add money to the system over the critical year-end, when banks make important calculations about the financial results and their solvency requirements. In total, the Bank will inject £11.35bn into the banking system in each of two auctions over the next five weeks.
Meanwhile, the Fed is opening up currency "swap lines" of $20bn and $4bn to the ECB and the Swiss central bank, respectively, sending them dollars that can be lent to troubled European banks. A dwindling of dollar assets in Europe has contributed to the high inter-bank interest rates being charged for dollar-denominated lending, particularly the closely-watched London inter-bank lending rate, Libor, off of which many other types of loans are priced.
Banks' reluctance to lend to each other stems from their own financial difficulties and from nervousness about their rivals' solvency. The industry has admitted more than $50bn of losses from bad bets on US mortgages. American homeowners are defaulting on their mortgage payments in record numbers, causing a cascade of financial losses on the mortgage-backed securities and other derivative products that use home loans as collateral.
Bank of America yesterday said it would have to set aside $3.3bn more to cover mortgage-related losses, and its smaller rival Wachovia said it was upping provisions by $1bn. Earlier in the week, the Swiss bank UBS said it had written down its portfolio of mortgage-related assets by an extra $10bn. Banks including UBS and the New York-based Citigroup have tapped overseas governments for multi-billion dollar cash infusions to help shore up their balance sheets.