Credit crunch hits the UK and Germany

With troubles at HBOS and Barclays hitting the headlines - plus suspicions that many others are struggling - credit markets are seizing up. Meanwhile, in Germany, the situation is even more critical.

The credit crunch has "inched closer to the heart of the British financial system", said Patrick Hosking in The Times. Banking group HBOS has announced that it would extend credit to a $37bn (£19bn) in-house fund that is struggling to finance itself.

What's worrying investors here?

The fund, Grampian, finances its investments with short-term commercial paper. But demand for commercial paper among banks and investors has dried up because it is often backed by assets that sometimes include subprime mortgage securities. Grampian apparently has scant subprime exposure, but investors are now reluctant to buy paper underpinned by both risky and low-risk assets, said Sean Farrell in The Independent.

Worries were also fuelled by the news that an unnamed UK bank (since reported to be Barclays) used the Bank of England's emergency lending facility; the £314m loan marks the first time since the credit crisis began that a financial institution has resorted to this. Banks occasionally use it for technical or operational reasons, as Jeremy Warner noted in The Independent; it doesn't necessarily signify trouble. But in this "fevered environment", it is just "plain daft" for the bank not to name the borrower and explain why there is no reason to worry. After all, nobody knows which banks or hedge funds are struggling, and the lack of transparency has made banks reluctant to lend to each other and "prompted a general seizing up of credit markets".

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

What's worrying investors in Germany?

The banking sector in Germany, meanwhile, is in a critical situation. Or presumably that's what West LB chief executive Alexander Stuhlmann means by a "not uncritical situation". He senses "a reluctance on the part of foreign partners to extend credit to German banks". No wonder. Two state-backed German banks, IKB and Sachsen LB, have required e8bn and e17bn bail-outs respectively, thanks to subprime mortgages. Both had issued reassuring statements about their finances shortly before the lifelines were announced. News of "dull regional banks" dabbling in exotic markets meant that even the big banks' shares such as Deutsche and Commerzbank got "hammered" as fears of contagion in the sector spread, said Carl Mortishead in The Times.

Germany has more banks than the UK, France and Italy combined, as Steve Goldstein notes on, and low profitability is one reason they are tempted by aggressive trading strategies. Another is state backing, said Mortishead; Sachsen LB knew its "big American adventure was supported by the sovereign guarantee of Saxony". It is now clearer than ever, said Lex in the FT, that the German banking industry needs "to speed up its restructuring".