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Key bank loan rate keeps climbing, a sign of rising stress in the financial system

The world’s big banks continue to grow leerier about lending to one another, a sign that the latest tensions in the financial system aren’t abating.

Still, warning signs in the credit markets are a long way from what we saw in late 2008, when the banking system was on the verge of a total meltdown.

The London interbank offered rate (Libor) for three-month dollar loans, a benchmark for short-term interest rates, crossed the half-percent mark Monday, rising to an annualized 0.5097% from 0.4969% on Friday.

The rate (charted below) now has nearly doubled since mid-March and has surged from 0.3053% just since early May, when Europe’s sovereign-debt crisis began to balloon, raising new fears about the health of the global financial system.

Libormay24 Libor is the rate that the biggest, most creditworthy commercial banks charge one another for loans. So its ascent -- in the absence of any credit-tightening moves by major central banks -- shows that financial institutions want to be paid more for the risk of making short-term loans to one another.

Confidence in the health of Europe’s banking system suffered another blow over the weekend after the Spanish government seized one of the country’s biggest savings banks. That helped to cut short last week's rally in the euro. The currency slumped to $1.237 on Monday from $1.259 on Friday.

In the U.S. one focus is on the potential fallout from Congress’ financial-system-overhaul plans. If the government is serious about ending the implicit “too big to fail” policy toward the largest lenders, those institutions could face downgrades in their credit ratings, the Wall Street Journal warned in a story Monday. If a bank's credit rating falls its cost of credit would be expected to rise.

Banking stocks led Wall Street lower Monday, with the 79 financial shares in the Standard & Poor’s 500 index falling 2.9% on average. The S&P 500 overall was off 1.3%. The Dow industrials slid 126.82 points, or 1.2%, to 10,066.57, taking back all of Friday's rebound of 125.38 points.

For the broader economy, one obvious concern is that higher interbank lending costs could filter through to corporate and consumer borrowers. “The tightening in financial conditions will produce slower [economic] growth if current strains do not abate soon,” said Michael Darda, chief economist at investment firm MKM Partners in Greenwich, Conn.

The three-month dollar Libor rate of 0.5097% now is the highest since July. Even so, it remains sharply below its levels of late 2008, when credit markets had seized up following the failure of Lehman Bros. The rate briefly rocketed as high as 4.818% in October 2008 from 2.876% just before Lehman’s collapse.

“Ultimately, Libor has done perhaps the best job of handicapping global financial stress,” Wall Street advisory firm Strategas Research Partners said in a report Monday. “As such, a decline in Libor may be the only real indication that investors are starting to have some confidence” that Europe’s financial turmoil won’t worsen, the firm said.

Libor has declined just once since early April: It eased slightly May 10, the day after the European Union announced a plan to lend nearly $1 trillion to struggling European governments over the next three years, if necessary. The relief was short-lived: Libor began to climb again May 11.

-- Tom Petruno

 
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