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Key bank rate hits new low as confidence rises

May 18, 2009 | 12:40 pm

Big banks' cost of borrowing money from one another has fallen to record lows in recent days, another sign that the financial system is inching closer to normalcy.

But that may just increase political pressure on bankers to make credit more available to cash-needy business and consumer borrowers.

A key short-term interest rate for banks -- the three-month London interbank offered rate (LIBOR) -- slid to 0.79% today from 0.83% on Friday and 1.05% three weeks ago.

LIBOR is what banks pay to borrow from each other. It’s also a benchmark for many floating-rate business and consumer loans (including some mortgages), which means the continuing slide in LIBOR rates should eventually filter through to other borrowers, notes John Lonski, economist at Moody’s Investors Service in New York.

At the height of the financial crisis last fall, three-month LIBOR spiked as high as 4.8% even as other short-term rates were crashing. That surge showed that bankers weren’t willing to lend to one another because of fear of a massive wave of bank failures.

Although LIBOR rates dropped sharply late last year, they were edging higher again this year -- until stock markets began to rally worldwide in early March, signaling that investor confidence was returning.

Since March 10, three-month LIBOR has tumbled more than half a percentage point to the current 0.79%. And the rate has dropped from 0.96% just since the Federal Reserve on May 7 released the details of its "stress tests" of 19 major banks.

The slide in LIBOR "is telling us that people actually believe the banking system will survive," said Ray Remy, head of fixed income at Daiwa Securities in New York.

And as their own cost of money declines, bankers have one less excuse for holding back from lending to creditworthy borrowers. (Think Congress won’t notice?)

Although LIBOR rates still are relatively high compared with the Federal Reserve’s target of zero to 0.25% for its own key short-term rate, the continuing slide in LIBOR "is a positive from any way you look at it," Remy said.

-- Tom Petruno