| Kavari on Liquidity Implications |
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| Written by Dr. Gift Kavari | ||||
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Until all hidden non-performing loans and substantial losses linked to the downturn in the US property market and sub-prime investments are fully disclosed by affected banks, further liquidity injection will do little to resolve the global liquidity crisis in the banking sector.
The international credit crunch, and its knock-on effects on both the global economy and its banking system, is the worst problem the global financial system has faced for at least the past two decades. Following huge non-performing loans in the US Sub-prime mortgage sector and unknown scale of bad debts evident since 2007, many international banks have become more reluctant to lend to each other. This unwarranted money market conditions has triggered a liquidity crisis in the global banking sector. The reason is that the full extent of sub-prime credit losses is still unknown. The severity of the liquidity crisis, has caused the global credit squeeze, and therefore has prompted major central banks to inject extra liquidity in the global financial markets. Cash injections of $210 billion in the Eurozone economies, $38 billion in the US$8.5 billion in Japan, and $4.19 billion in Australia in August 2007, did not ease the financial turmoil. Consequently, increased financial uncertainties have roiled the global stock markets, resulting in billions of dollars, pounds and euros being wiped off share values, hitting businesses and individual investors. To ease liquidity squeeze, cash injections of $65.8 billion in the Eurozone economies and in the United Kingdom in September 2007 caused the London Interbank Offered Rate (Libor) to increase to 6.79%, which traded above the Bank of England’s emergency lending rate of 6.75%. The surge in Libor, which averaged 5.5% in the last quarter of 2007, has pushed up the cost of borrowing worldwide. LIBOR is an average of the interest rate on dollar-denominated deposits (Eurodollars) traded between banks in London and is therefore an international index, which follows the world economic condition. It allows international investors to match their cost of lending to their cost of funds. The challenge for major central banks was therefore, to cut the cost of global credit, and to restore confidence in the short-term inter-bank credit markets, which led to another $100 billion cash injection in December 2007. Nevertheless, the global credit crunch has deepened and widened throughout the first six months of 2008. In March 2008, about $200bn liquidity injections into the global financial market was announced in order to ease the credit crunch and its impact on the global economy. The US Fed (central bank) has created a Term Securities Lending Facility (TSLF), to promote liquidity in the financial sector, lending up to a total of $200bn in US Treasuries for a term of 28 days instead of overnight. To attract foreign capital inflows, the US Fed funds rate was cut seven times from 5.25% in September 2007 to 2% in March 2008. At the same time, the Fed took the unprecedented step at least since the Great Depression of allowing non-depository investment banks to borrow directly from its coffers, in exchange for mortgage-backed debt and other speculative securities whose market value has plummeted in the wake of the housing bust. The Fed subsequently acknowledged that it took these measures to avoid a likely collapse of the entire financial system. In so doing, it assured the banking and investment industry that the full resources of the US government would be marshaled to shield them from the consequences of years of rampant speculation, predatory lending practices, deceptive and fraudulent accounting methods. |
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