Saturday, June 28, 2008

Banks raise billions as credit crisis gets worse and liquidity is squeezed

This time its the turn of the European Banks to take the hit - and that right on their balance sheet!! Due to subprime mortgage, short-term lending is poised to rise again even as central bankers are pumping billions and billions of dollars into their businesses.

This may be summed as an 'end-of-the-quarter' effect, where banks pump in a lot of cash to make their balance sheets look stable [even in the worst times] mainly to boost investor confidence and trump their competitors. Cold, hard cash is raised through a variety of processes, including international funding, and borrowing dollars from Americans (probably Federal Reserve...) and selling part-stakes (Merrill Lynch, Citigroup, Lehman Brothers did that last year to ADIA Sovereign Wealth Fund, and Bear Stearns sold itself fully to JP Morgan)

Latest reports also suggest Fed providing a tens of billions of dollars to central banks in France and Switzerland to help them overcome this financial mess.

Other American banks, saddled with huge write-downs in bad debts, have to bolster their red-inked ( full of losses) balance sheets too in the wake of this credit crisis. Notes one analyst, 'The quicker the capital is raised, the quicker it is lost nowadays'. Banks are also anxious to insure themselves against future losses from credit swaps and corporate loans on mortgage securities.

So why do you think the above situation is getting exacerbated ???

The answer lies in the title of my article - their is an unusual hyper demand for dollars from European banks that is creating a liquidity squeeze in the market since a year. The advantages to Europe are simple - interest rates being so low in USA, make it tempting to borrow at such low rates. Secondly, some banks are forced to borrow dollars so that they, in turn, can invest this money into dollar-driven investments(the financial investments made only in dollars - as it is a de facto currency of the world presently).

But all this may take a dynamic twist when the Fed revises its interest rates(i guess upwards this time) from a paltry 2%. What do you say about the above?? I'd like to hear your views....

I am signing off with my thoughts," It took a lot of years to set up this financial model, a single year to destroy it completely, and it sure requires a long time for healing it."

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