BIS: Only central banks can stem liquidity crisis

December 11, 2011

BIS: Only central banks can stem liquidity crisis

London - The Bank for International Settlements Sunday issued an oblique endorsement of coordinated action by the world's largest central banks to ease funding conditions for banks.

"A freezing of interbank markets in major funding currencies, as during the recent crisis, may require the ability to supply official liquidity in major currencies in an elastic manner," the BIS wrote in its regular quarterly report. "Only the currency-issuing central banks have this ability."

The U.S. Federal Reserve 10 days ago agreed to expand, and reduce the cost of, multilateral swap lines with five other large central banks, notably the European Central Bank, in an effort to restore access to dollar funding for European banks.

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Euro-zone banks used the new facility to borrow $50.7 billion at a rate of 0.59% at the first operation after the announcement.

The BIS's essay was its latest in a series analyzing the concept of global liquidity, and focused again on the interplay between official liquidity, that is, created by central banks, and the far greater liquidity created by the private sector on the basis of central bank money--the so-called money multiplier.

The essay observed that much is still unknown on this topic, particularly on the degree to which the accumulation of foreign exchange reserves by central banks, and their subsequent reinvestment, can affect the creation of private liquidity.

The BIS noted that the priority of policymakers should be to mitigate surges in the overall level of global liquidity. It said the new "Basel III" rules on capital and liquidity should help this trend of "counter-cyclical" policymaking.

The BIS noted that it is still impossible to track global liquidity levels with precision, but argued that international credit aggregates, especially levels of cross-border lending, have tended to act as advance indicators of trends in the past.

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