Page last updated at 21:01 GMT, Tuesday, 11 March 2008

Central banks fight credit crisis

Federal Reserve building
Five central banks have announced co-ordinated action

The world's largest central banks have launched their latest co-ordinated action to calm jittery credit markets.

The US Federal Reserve, the European Central Bank and central banks in the UK, Canada and Switzerland will inject billions of dollars into money markets.

The news cheered investors and US stocks surged more than 3% - their biggest one-day gain in five years.

The injection of more than $200bn is aimed at easing the credit crunch and its impact on the wider economy.

On Wall Street, the benchmark Dow Jones industrial average soared 416.66 points, or 3.55%, to close at 12,156.81.

In London, the FTSE 100 index of leading shares ended 1% higher.

It's not that banks don't have cash to lend; it's that they don't trust each other to have sufficient assets
Evan Davis, BBC Economics Editor

"The key to any sustainable rally is going to be an improvement on the credit side," said Michael Darda, chief economist at MKM Partners.

"But this is positive. The Fed's making a major effort to get liquidity and credit into the cracks and crevices of the financial system that need it the most."

The dollar rose sharply against the yen and rebounded from a record low against the euro.

Crunch continues

The authorities are worried that the credit crunch shows few signs of easing, eight months after the crisis began.

Prospective home buyer

In the UK, mortgage lenders announced a sharp slowdown in the number of home loans that are being approved due to the difficulties that many banks face raising funds on commercial money markets.

The crisis in credit markets has threatened world economic growth and many expect the US, the world's largest economy, to enter a recession.

The problems in credit markets emerged last summer when banks began revealing losses related to investments in the ailing US housing market.

Record defaults on US home loans, especially to sub-prime borrowers with poor credit histories, caused the value of these assets to plunge and made banks reluctant to lend to each other.

'Crisis of confidence'

BBC Economics Editor Evan Davis questioned whether the central banks' actions would help re-instil confidence into nervous credit markets in the longer term.

He says the banks' actions could help solve any liquidity problems - a temporary shortage of cash - faced by financial institutions, but would do little to ease worries about long-term solvency at some financial institutions.

"We have been in a second phase of the credit crunch which has seen a reluctance for banks to lend to each other not out of liquidity shortages, but out of a general worry that the banks they lend to won't be able to pay them back," he said.

"It is, in other words, a crisis of confidence in bank solvency. It's not that banks don't have cash to lend; it's that they don't trust each other to have sufficient assets."

Specific measures

Each of the central banks announced measures specific to their own markets, which follow on from similar emergency auctions of cash in December.

The US Federal Reserve is making up to $200bn (99bn) available to financial institutions for 28 days instead of the usual overnight auctions.

"Pressures in some of these markets have recently increased again," the US central bank said in a statement.

"We all continue to work together and will take appropriate steps to address those liquidity pressures."

The Fed will also allow financial institutions to borrow the money using risky assets as collateral.

These assets could include mortgage-backed securities - the source of the current crisis in credit markets.

'More clarity needed'

The Fed is also extending a "swap lines" scheme, that will provide $30bn and $6bn through the ECB and the Swiss National Bank respectively.

The ECB is also making available another $15bn, despite having said on Friday that it had no plans to do so because the market problems that had made the last auctions necessary were no longer there.

The British Bankers Association welcomed the auctions but called on the Bank of England to provide more details about them.

"We would urge the Bank of England to provide greater clarity on the range of acceptable collateral, the minimum bid rate, and whether these operations will continue beyond April," director John Ewan said.

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