Central banks try again to lift liquidity

Several of the world's most prominent central banks, led by the US Federal Reserve, overnight announced details of the latest scheme - basically looser lending, by them, to select counterparties - that they hope will help revive liquidity in interbank markets.

This is the latest in a series of interventions devised by central banks over the last six months to address the seven-month-old dislocation in world markets that continues to topple smaller financial institutions and that has magnified the risk spreads paid by banks on their debts, with the increased costs pushed onto borrowers.

Last night's innovation is the decision by the US Fed to undertake a series of weekly auctions with primary dealers under which the Fed will lend up to US$200 billion in aggregate for terms of 28 days, rather than overnight as at present.

One practical feature of the auctions is that it may allow primary dealers to sell AAA-rated mortgage-backed securities to the US Fed on more favourable terms.

The second dimension to the plan is that the US Fed will increase the currency swap arrangements it put in place with the European Central Bank and the Swiss National Bank by US$10 billion (to US$30 billion) and US$2 billion (to US$6 billion) respectively. The terms of the swap agreements now last to the end of September 2008.

The introduction of these swap agreements themselves, back in early December 2007, was intended at the time to be a circuit breaker to the interbank market, though its effectiveness then was doubtful.

Both before and after, the Fed and other central banks have devised interventions, including extending the discount window, allowing the use of a wider range of securities in repurchase agreements.