THE GOVERNMENT'S bank guaranteed scheme has been approved by the Dáil amid signs that conditions in the short-term money markets are starting to improve as banks resume lending to each other. The scheme was approved by 114 votes to 22 with Fine Gael supporting its terms, while Labour and Sinn Féin voted against.
Minister for Finance Brian Lenihan told the Dáil that the scheme covering the six Irish banks and subsidiaries of foreign banks with a significant "main street" presence in Ireland had played a crucial role in maintaining financial stability in Ireland over recent weeks.
"The State is unconditionally and irrevocably guaranteeing the covered liabilities of the participating institutions until September 29th, 2010. The Minister will pay forthwith any valid claim on the guarantee," he said.
Meanwhile, the cost to banks of borrowing has finally started to fall as intervention from central banks saw inter-bank lending rates for the dollar, euro and sterling fall this week. There were particularly sharp declines in short-term rates, indicating that the latest moves to boost funding options for banks are starting to pay off.
Overnight London inter-bank offered rates (Libor) for euro funds fell to 3.66 per cent, almost nine basis points below the ECB's 3.75 per cent target, which suggests that the market expects the ECB to cut interest rates again soon.
Overnight sterling Libor plunged almost half a percentage point to 4.69 per cent, closer to the Bank of England's 4.5 per cent target; one-week dollar Libor was fixed at 1.67 per cent, more than a quarter percentage point down from the previous day's fix and near the Federal Reserve's 1.5 per cent target.
However, longer term rates have barely moved and the three-month sterling spread actually rose on Thursday by five basis points.
The inter-bank markets had been frozen because of concerns over counter-party risk - whereby banks were scared to lend to each other in case the borrower defaulted on the loan.
Although the Government's bank guarantee, combined with similar initiatives throughout Europe, solved this problem, it still wasn't sufficient to revitalise inter-bank markets.
According to Donal O'Mahony, global strategist with Davy Capital Markets, the other major problem which the guarantees did not address was liquidity risk. In the absence of normally functioning inter-bank markets, banks would not lend out significant sums of money in case they were hit with a major redemption, which they then would not be able to fund by borrowing the sum themselves.
However, on Wednesday, the ECB moved to solve this problem, albeit in a circuitous fashion, when it extended its range of eligible collateral to include assets with a lower credit rating than previously and, crucially, a new instrument, deposit certificates, thereby implicitly transforming itself from being a "secured lender of last resort" to an "unsecured lender of last resort".
- (Additional reporting Reuters)
