U.K. Interbank Lending Fell 68% in July From Year Ago

By Jennifer Ryan and Gavin Finch
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Sept. 1 (Bloomberg) -- Lending between U.K. banks slumped 68 percent in July as financial institutions hoarded cash to shore up their balance sheets, signaling Bank of England efforts to revive money markets aren't working.

The volume of interbank lending in the British currency fell to 205 billion pounds ($370 billion), from 635 billion pounds in July last year, according to central bank data published today. Lending averaged 269 billion pounds a month since the credit crunch started in August 2007.

Banks are curtailing lending while losses from the collapse of the U.S. subprime-mortgage market climb above $500 billion. Interbank lending rates are little lower now than they were in April, when the Bank of England offered to take on damaged mortgage-backed bonds in an effort to unfreeze lending. The strains in global money markets will probably persist ``for some time,'' the Bank for International Settlements said today.

``We're in the same position we were in last year, with banks hoarding cash to refinance their own beleaguered balance sheets,'' said Christoph Rieger, a fixed-income strategist at Dresdner Kleinwort in Frankfurt. ``The Special Liquidity Scheme has helped individual banks by preventing them from becoming illiquid, but it hasn't helped money markets return to normal.''

The July figure, which excludes central bank transactions, is up from 195 billion pounds in June. The total peaked at 656 billion pounds in February last year, and has averaged 270 billion pound since the data began in 1997.

Brink of Recession

The central bank program allows commercial banks to swap mortgage-backed securities harmed by the credit squeeze for government bonds. The lending freeze led to the collapse of mortgage lender Northern Rock Plc in September, triggering the first run on a U.K. bank in more than 140 years.

The credit famine and the fastest inflation in at least a decade have brought the U.K. to the brink of a recession. Gross domestic product stagnated in the second quarter, ending the nation's longest stretch of economic growth in more than a century, according to government data.

Bank of England Governor Mervyn King said in June he will unveil a new money-market system this year to cope with both ``normal'' and ``stressed'' conditions. He hasn't said when or whether banks will reveal their participation in the April plan.

``It's significant that lending volumes have stopped falling, but what's worrying is the level where they've stabilized,'' said Lena Komileva, an economist at Tullett Prebon Plc in London. ``This new order reflects weak confidence in credit quality as a result of banks struggling to refinance their loan books. It's a striking illustration of a crisis at its height.''

Pressures `Continue'

Interest-rate derivatives imply that banks are becoming more hesitant to lend on speculation credit losses will increase as the global economic slowdown deepens.

The premiums banks charge each other for three-month cash relative to the overnight indexed swap rate widened to 78 basis points today from 12 basis points on July 31, 2007, before the credit crunch took hold in the U.K. It has averaged 69 basis points in the past 12 months, up from an average of 11 basis points in the preceding year.

``The term structure of Libor-OIS spreads suggests the interbank market pressures are expected to continue for some time,'' Ingo Fender and Jacob Gyntelberg, analysts at the BIS, wrote in the Basle-based bank's quarterly report.

The increase in short-term borrowing costs triggered questions over the accuracy of the London interbank offered rate, the benchmark interest rate administered by the British Bankers' Association and used to calculate rates on $360 trillion of financial products worldwide.

The BIS said in March some banks may have understated their borrowing costs to avoid being seen as having difficulty raising financing.

To contact the reporters on this story: Jennifer Ryan in London at Jryan13@bloomberg.netGavin Finch in London at gfinch@bloomberg.net