Libor rate rise threatens banking system

Libor rates have rocketed after an extraordinary two days of turmoil on Wall St that left two investment banks destroyed and the largest insurance company in the US on the verge of collapse.

Banks are now hoarding cash to cover themselves against losses caused by trades with Lehman Brothers, and uncertainty over the future of AIG.

The result has been to send the Libor to over 6%, and now the highest rate for seven years, according to the London Evening Standard.

The London Interbank Overnight Rate (Libor) is the rate at which banks across the world lend to each other - the lower the rate, the more accessible cash usually is.

Most lenders tap into this commercial market, to differing degrees, to help fund not simply their business expansion, but also their daily operations,

A big cause of the Credit Crunch was the shutting off of money to commercial markets while financial companies started to hoard their own cash to protect themselves against losses from toxic investments.

The collapse of Lehman Brothers has resulted in yet another bottleneck in lending just when the world needed it least.

While the Bank of England offered £20 billion in short-term funding yesterday, this was over-subscribed. Yet today the BoE only made £5 billion available.

Central banks around the world have been providing cash to help grease the financial wheels of commercial markets, but they cannot guarantee that any of this cash will filter down to those smaller financial institutions which need it the most to avoid collapse.

HBOS became a dramatic example of what this could result in - even with larger lenders - when the rising Libor rate caused investors to worry about the ability of HBOS to fund its business.

The result was that HBOS saw it share value plummet 35% at one point during London trading.

While analysts believe HBOS to be adequately capitalised at present, any continuation of high Libor rates could cause serious problems for HBOS and other lenders with significant exposure to mortgages.

The result could reverse any tentative recovery from the Credit Crunch over the summer, and extend the financial crisis for an extra year.

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