In recent days, central banks have pumped vast amounts of liquidity into the short-term lending markets, only for banks to hoard the cash and not lend to other banks. As well as the rate cuts, the US Treasury tried to alleviate lending problems in government bond markets by making more of its bonds available for collateral.
“The concerted central bank rate cuts should provide some relief in [Thursday's] fixings, but the funding will remain very tight, with negative effects on the economy mounting,” said TJ Marta, strategist at RBC Capital Markets. The breakdown in trust between lenders and borrowers since the bankruptcy of Lehman Brothers in mid-September has paralysed short-term funding markets. Institutional investors are unwilling to risk lending unsecured funds to banks, or even buy commercial paper beyond one day issued by highly rated companies.
The reluctance to lend between banks and other investors has also created chaos in the government repurchase or repo market, another important source of short-term funds for banks. In a repo transaction, sellers of debt securities promise to buy them back later for an agreed price.