Ravi Kant

19 December 2007, Wednesday

The sub-prime crisis has eroded wealth of several banks in Europe, USA and UK. Banks have become suspicious in lending even to other banks. There is suspicion everywhere that any bank might declare huge loss due to sub prime crisis at any point of time. According to the report, banks in sub-prime affected country have become scary of lending.

The decision of ECB was the result of overly wishful thinking of the world’s central banks to introduce greater liquidity in global capital market. Few days back (12 December 2007), United States of America’s Federal Bank, Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank were agreed on the plans to auction bonds of tens of billions of dollars and lend the funds collected through such auctions to the sub prime affected banks.

Central banks issued huge amount of bonds to banks / public to mop up the cash from the banks and ultimately lent the money to those banks that were facing liquidity crunch. It was believed that many banks were sitting on the cash and were not ready to lend in the market not even in the financial market or to their fellow banks also.

Owing to the central banks and sovereign guarantee of governments of the respective countries, these bonds were expected to be fully subscribed with good rates. The banks having huge cash will subscribe those bonds and ultimately central banks will lend the collected funds to the ailing banks and financial institutions.

In an effort to correspond the huge losses faced by financial institutions like Citigroup, Merryl Lynch and Bank of America, the goal of the leading central banks is to limit growing risk aversion, which has caused banks to significantly rein in lending. The move was primarily designed to boost the confidence in the equity market.

After this, the Bank of England also auctioned 10 billion pounds (billion) as three-month loan to its banks. The emergency funds loaned to the banks will make easier access to the money in these countries.

Uniting several central banks on a single forum and starting a conscious step for a common cause collectively is certainly a commendable task. We undoubtedly have to patiently wait for some time to watch the effect of the short time measures.

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