Page last updated at 12:58 GMT, Thursday, 25 September 2008 13:58 UK

Rush for Bank of England funding

Bank of England
The Bank of England's cash auction was heavily over-subscribed

Banks have scrambled for extra funding at this week's regular cash auction by the Bank of England.

Commercial banks asked for 89.2bn ($165.5bn) in the auction - far more than the 52.8bn that was available.

Strains in the money markets have risen rapidly following the collapse of the US investment bank Lehman Brothers.

Banks are turning to the Bank of England for loans because it is currently too expensive to borrow from other banks as they would usually do.

Market stress

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The central bank made an extra 5bn available at this week's auction because of the shortage of funds in commercial markets, but analysts said there was clearly appetite for more.

"Commercial banks' use of the Bank of England's deposit facility is another symptom of the current illiquidity in the banking system," said David Page, an economist at Investec.

"There is presently very little lending between banks," he added.

One measure of the stress in the money markets is the difference between two key market rates: Libor and the Bank of England's base rate or official rate.

Libor, or the London Interbank Offered Rate, is the rate at which banks lend money to each other.

While central banks such as the Bank of England set official rates, Libor is seen to show the real rate of interest being used by the largest firms to borrow from one another.

The most basic function of the banking system, to channel funds at the right price to those who can best use it, has broken down

Robert Peston, BBC business editor

It has been an important barometer of the credit crunch.

The difference, or spread, between these two rates has risen since the US investment bank Lehman Brothers filed for bankruptcy. Analysts said this reflected worries about the planned US financial bail-out.

Hoarding cash

"Sharp rises in Libor rates are something we are seeing not just in the UK but around the world," said Mark Capleton at Royal Bank of Scotland.

"It reflects acute nervousness as the US financial rescue plans make their way through Congress."

The BBC's business editor Robert Peston said that hoarding by bankers was on the rise.

He said given the choice between lending or keeping their cash close at hand, bank treasurers were opting for extreme caution.

Some banks have even preferred to leave their cash overnight with the Bank of England, despite earning a lower interest rate than that which would offered by other banks.

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