Thursday, 5 March 2009

Interbank money exchange

From an unusual source (John Reid, chairman of Celtic Football Club - oh, and the UK's former Home Secretary) comes a proposal for international exchanges for interbank lending.

Tim Worstall understandably dislikes the idea that the interest rate is the same regardless of who the borrower is. But that is partly addressed by the insurance premium that would be paid by all borrowers.

My question is different: is interbank lending still the problem? I have the feeling that the interbank market no longer suffers from the problems it had last year - LIBOR/TED spreads are down and governments have effectively guaranteed the majority of interbank loans.

Instead it seems that the problem in the financial economy is either demand for or supply of credit to the non-financial sector. This is resulting in a shrinkage of money in circulation and - since it's not compensated by an increased velocity of money - reduced prices or GDP.

Still, it's not a ridiculous idea. Perhaps instead of being a direct counterparty in loans, the central bank can play a marketmaker role; providing liquidity and some mitigation of counterparty risk. I just suspect this is a solution for a problem that's no longer urgent.

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