LONDON | Britain's interbank interest rate rose to its highest level in more than seven years as banks increased their reluctance to loan money to rivals until the extent of British banks' exposure to the U.S. mortgage market is better known.
The jump in key three-month interbank lending rates puts the Bank of England under pressure to tackle the growing crisis. Unlike its counterparts in Europe, Asia and the United States, the British central bank has so far rejected calls to inject cash into markets.
The three-month interbank rate, or LIBOR, now sits at 6.7975 percent, more than a full percentage point above the 5.75 percent base rate in Britain and above the central bank's emergency lending rate of 6.75 percent, indicating that confidence is very low.
The last time LIBOR was at such high levels was for a very brief period in June of 2000. Its last sustained period at such a high level was after the collapse of the U.S. hedge fund Long Term Capital Management in 1998.
The current rate reflects banks' reluctance to loan funds to rivals at anything but a premium until they know the extent of the mortgage crisis. By raising their interbank rates, banks can hold on to their own liquidity, staying shy of potential borrower's exposure to the U.S. subprime mortgage market.
Companies in both Britain and the United States use LIBOR to hedge currency exposure or change financing through interest swaps, leading to concerns about what happens when existing arrangements hit maturity.
Shrinking credit levels started with rising defaults in U.S. subprime mortgages, or home loans made to people with weak credit histories. It has spread because banks have repackaged risky loans with the more reliable, and sold them to a wide range of investors, including several European banks.
British bankers report that liquidity remains at the shorter end of the lending market, such as overnight and weekly lending, and that the availability of three-month money had almost entirely dried up.
"The interbank lending business has broken down almost completely ... Financial institutions are precautionary in hoarding liquidity because no one knows which losses might occur," analysts at UniCredit said in a note to clients.
The challenge for the Bank of England is what action to take -- if any.
The European Central Bank and the U.S. Federal Reserve have joined other central banks in Europe and Asia in making a series of cash transfusions to support markets, but Britain's central bank has so far declined to do the same.
It is apparently taking the stance that risk levels are being repriced naturally by the market, but has declined to respond publicly to a recent onslaught of criticism over its inaction, maintaining its traditional silence on such issues.
On the one hand, the act of intervention itself could spur panic in the markets by suggesting a major problem that needs to be fixed.
On the other, if the central bank does not inject funds into the short-term market, confidence could be dented further, potentially leading a smaller institution into insolvency in a worst-case scenario.
If that happens, fears will be cemented as reality as prices rise further and credit dries up across the short-term as well as the medium-term.
