World's central banks act to ease market strains

The U.S. Federal Reserve, European Central Bank, Bank of England and the central banks of Canada, Japan and Switzerland were all taking part.

"The purpose of these actions is to ease strains in financial markets and thereby mitigate the effects of such strains on the supply of credit to households and businesses and so help foster economic activity," the central banks said in a joint statement.

As Europe's debt crisis has spread, the global financial system is showing signs of entering another credit crunch like the one that followed the 2008 collapse of U.S. investment bank Lehman Brothers. Banks are afraid to lend to each other, since no one is really sure what institutions are holding how much bad government debt.

Greece, Ireland and Portugal have all been forced to take international bailouts, and Italy, Spain and Belgium are seeing their borrowing costs rise sharply. Banks already had to agree to forgive 50 percent of the value of their Greek debt holdings -- and many fear that other struggling European countries might also demand a so-called "haircut" on bonds.

A ratings downgrade by Standard & Poors for six major U.S. banks on Tuesday added to fears that Europe's woes would hurt the entire financial system. If one or more European governments default, that would unleash a shock to the world's financial system that at the very least would lead to recessions in the United States and Europe, severe losses for banks and a global stranglehold on lending.

The central banks agreed to reduce the cost of temporary dollar loans they offer to banks -- called liquidity swaps -- by a half percentage point. The new, lower rate will be applied to all central bank operations starting Monday.

The cut means that the charge will fall to 50 basis points -- or one-half percentage point -- over an international benchmark, the overnight index swap rate, which is averaging around seven to 10 basis points currently.

Non-U.S. banks need dollars to fund their U.S. operations and to make dollar loans to companies that need the U.S. currency. The dollar is the world's leading currency for central bank reserves and is widely used in international trade.

"Obviously, these moves are designed to increase the flow of dollar liquidity to European banks, which are struggling to attract short-term funding because of questions about their exposure to potential losses on holdings of European sovereign bonds," said Paul Ashworth, chief U.S. economist at Capital Economics.

He explained that Wednesday's move does not expose the Fed to propping up ailing European banks.

"The ECB actually makes the loans to these banks, so the Fed is not on the hook for any losses if a European bank failed," Ashworth added.

The announcement also extended the length of time the temporary dollar lines will be available by six months to Feb. 1, 2013. The swap line program had been scheduled to end Aug. 1, 2013.

According to Federal Reserve figures, US$2.4 billion in swap lines were being used as of last week. By comparison, at the height of the 2008 financial crisis, US$580 billion was provided in temporary swap lines in December of that year.

The aim of the announcement Wednesday was to increase liquidity, or the availability of ready money, by making it cheaper for central banks to tap the swap lines to provide dollars to their local banks. The expectation is that this will increase use of the swap lines and ease liquidity pressures.

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