Governments around the world are recapitalising banks, injecting liquidity into the markets and lowering interest rates. I'm confused. How are each of these measures different and how do they help?
RECAPITALISING
· What is it? The central bank buys shares in a bank. This gives the latter more capital, or more money to spend, in return for some commitments it must fulfil. The central bank effectively gets an ownership stake in the bank.
· Who's doing it? Widely regarded as the best tool available. Countries are adopting variations of this, with central banks in Britain and Europe requiring the banks to accept their money.
In the United States, the government is encouraging banks to ask for money on a voluntary basis.
· How effective is it? Right now, it seems to be working. Stock markets rebounded when central banks in Europe, the US and Japan announced they would adopt this plan. The British government has already bought stakes in the Royal Bank of Scotland and HBOS and Lloyds TSB.
· How much will it cost? The US will use US$250 billion (S$365 billion), while the UK, France and Germany have pledged some ¥150 billion.
GUARANTEEING LENDING
· What is it? The central bank will ensure, for a period of time, that any money lent by a bank will be protected so that even if the borrower defaults on the loan, the bank will get its money back.
· Who's doing it? Again different variations of this are being adopted. Central banks in Europe are guaranteeing lending between banks. The US Federal Deposit Insurance
Corp is guaranteeing all new bank debt for a fee and all small business deposits. Australia, New Zealand and Hong Kong will guarantee all bank deposits.
· How effective is it? Experts expect this move to finally unfreeze the credit markets.
· How much will it cost? Germany has set aside ¥400 billion (S$799 billion), France some ¥320 billion and Spain ¥100 billion.
INJECTING LIQUIDITY
· What is it? The central bank provides more funds to banks by lending to them.
· Who's doing it? Most central banks, even Singapore's, have done it recently at different times, in efforts to encourage banks to lend to one another.
· How effective is it? Has not boosted lending between banks because the fundamental problem of confidence was not addressed.
Libor and Sibor interest rates, an indication of overnight lending, stayed high. Banks simply held on to the money or would put it in safe assets like US treasuries.
CUTTING INTEREST RATES
· What is it? Cutting the cost of borrowing from banks.
· Who did it? On Oct 8, in an unprecedented move, the US Federal Reserve, the European Central Bank, the Bank of England and central banks in Canada, Switzerland and Sweden cut lending rates by 50 basis points. Other central banks have since followed.
· How effective is it? The move sent a good signal that central banks were prepared to work together, though credit markets stayed clogged. But interest rate cuts are a tried and tested means of boosting growth in a flagging economy as they help to spur new spending or investment. The International Monetary Fund expects global growth to slow to 3 per cent next year. With more countries facing slowing growth, further interest rate cuts seem likely.
ROBIN CHAN
RECAPITALISING
· What is it? The central bank buys shares in a bank. This gives the latter more capital, or more money to spend, in return for some commitments it must fulfil. The central bank effectively gets an ownership stake in the bank.
· Who's doing it? Widely regarded as the best tool available. Countries are adopting variations of this, with central banks in Britain and Europe requiring the banks to accept their money.
In the United States, the government is encouraging banks to ask for money on a voluntary basis.
· How effective is it? Right now, it seems to be working. Stock markets rebounded when central banks in Europe, the US and Japan announced they would adopt this plan. The British government has already bought stakes in the Royal Bank of Scotland and HBOS and Lloyds TSB.
· How much will it cost? The US will use US$250 billion (S$365 billion), while the UK, France and Germany have pledged some ¥150 billion.
GUARANTEEING LENDING
· What is it? The central bank will ensure, for a period of time, that any money lent by a bank will be protected so that even if the borrower defaults on the loan, the bank will get its money back.
· Who's doing it? Again different variations of this are being adopted. Central banks in Europe are guaranteeing lending between banks. The US Federal Deposit Insurance
Corp is guaranteeing all new bank debt for a fee and all small business deposits. Australia, New Zealand and Hong Kong will guarantee all bank deposits.
· How effective is it? Experts expect this move to finally unfreeze the credit markets.
· How much will it cost? Germany has set aside ¥400 billion (S$799 billion), France some ¥320 billion and Spain ¥100 billion.
INJECTING LIQUIDITY
· What is it? The central bank provides more funds to banks by lending to them.
· Who's doing it? Most central banks, even Singapore's, have done it recently at different times, in efforts to encourage banks to lend to one another.
· How effective is it? Has not boosted lending between banks because the fundamental problem of confidence was not addressed.
Libor and Sibor interest rates, an indication of overnight lending, stayed high. Banks simply held on to the money or would put it in safe assets like US treasuries.
CUTTING INTEREST RATES
· What is it? Cutting the cost of borrowing from banks.
· Who did it? On Oct 8, in an unprecedented move, the US Federal Reserve, the European Central Bank, the Bank of England and central banks in Canada, Switzerland and Sweden cut lending rates by 50 basis points. Other central banks have since followed.
· How effective is it? The move sent a good signal that central banks were prepared to work together, though credit markets stayed clogged. But interest rate cuts are a tried and tested means of boosting growth in a flagging economy as they help to spur new spending or investment. The International Monetary Fund expects global growth to slow to 3 per cent next year. With more countries facing slowing growth, further interest rate cuts seem likely.
ROBIN CHAN
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