The LIBOR is thawing...will it really help lending?

[fx_tactician]

by Patrick Patterson, IntegrityFX.com

The credit crisis is not easily defined, but the major reason for it is the unwillingness of banks to lend to each other, to say nothing about the common man. It seems counter-intuitive but banks often lend money they don’t have to lend. When they do this, they must borrow from other banks (if they can). This is done through the interbank lending market.

Banks are required to hold an adequate amount of liquid assets, such as cash, to manage any potential withdrawals from clients. If a bank cannot meet these liquidity requirements, it will need to borrow money in the interbank market to cover the shortfall. Some banks, on the other hand, have excess liquid assets above and beyond the liquidity requirements. These banks will lend money in the interbank market, receiving interest on the assets.

The interbank rate is the rate of interest charged on short-term loans made between banks. There is a wide range of published interbank rates, including the LIBOR, which is set daily based on the average rates on loans made within the London interbank market.

The London Interbank Offered Rate (LIBOR) is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale money market (or interbank market). The LIBOR rates provide the basis for some of the world’s most liquid and active interest rate markets. It is especially important to the US dollar.

Recently we’ve seen the LIBOR rate set a record high! When banks with liquidity won’t lend to banks without liquidity, we get a credit crisis. This is the reason that the US Federal Reserve has made $540 billion dollars available to mutual funds and why the US Treasury has bought $250 billion dollars worth of shares in the 9 largest U.S. banks. They are trying to get incentivize institutions to lend money. However, liquidity by itself is not an incentive to lend money. Many banks are simply hoarding the money and protecting their assets.

Here are three things that need change. First, investors will have to stop pulling their money out of the markets. There is no need to lend to people liquidating positions. Second, banks will need to have renewed faith in people and institutions that have been labeled as credit risks. It has become apparent that having a triple A credit rating is not a clear indication that a lender is unlikely to default. Finally, we will need to restructure the credit system, so that lending practices are improved and credit defaults by major corporations and banks are not back stopped by the government.

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