In an unusual step, the Bank of Canada said Thursday it will "provide liquidity to support the stability of the Canadian financial system and the continued functioning of financial markets."
"The bank is closely monitoring developments, and will deal with issues as they arise," it said in a statement.
By mid afternoon, the central bank had made more than $1.6 billion available to Canadian banks at its regular interest rate, far more than its recent cash infusions into the financial system.
Such a public reassurance is rare – the last time it happened in Canada was following the Sept. 11 terror attacks in New York and Washington. But it shows how worried regulators have become over the credit crunch that is raising interest rates and making it tougher to borrow in financial markets.
In Europe, worries that liquidity was drying up because some banks are unable to value securities backed by subprime – or high-risk – U.S. mortgages pushed the European Central Bank to inject a torrent of cash into markets, lending more than US$130 billion in overnight funds to banks at a bargain rate of four per cent.
The U.S. Federal Reserve, the world’s most powerful central bank, added $24 billion to the banking system.
"This is a mini-panic," said Joseph Battipaglia, chief investment officer at Ryan Beck & Co. in New York, calling the central banks’ injection of money unprecedented evidence that problems in subprime lending are spilling into the general economy.
"All the things that had been denied up until this point are unravelling."
The credit fears pushed North American markets deeply into the red Thursday, with both the TSX and New York closing down – the Dow nearly 400 points lower – in a volatile trading day that started bad and only seemed to get worse.
The culprit was U.S. credit liquidity worries, which surged back to the forefront of investor concerns after news that French bank BNP Paribas is freezing three funds that have struggled amid the shaky U.S. mortgage market.
Toronto’s S&P/TSX composite index ended down 280.18 points to 13,478.01, while the Dow Jones industrial average was down 387.18 at 13,270.68, at its lowest level of the day.
Meanwhile, the Canadian dollar fell 0.71 of a cent to 94.65 cents US after briefly losing nearly a penny and a half in earlier trading.
The loonie’s struggle is connected to the credit worries, said Avery Shenfeld, currency specialist at CIBC World Markets.
"The Canadian dollar has been tied up in the same phenomenon, so when there’s talk that hedge funds will have to be cutting back on their leverage, the currencies that had earlier been rallying are the ones that are sold off," he said.
The announcement by BNP Paribas raised the spectre of a widening impact of U.S. credit market problems. The idea that anyone – banks, investors, companies, ordinary consumers – can’t get money when they need it unnerved a stock market that has suffered through weeks of volatility triggered by concerns about tight credit and bad subprime mortgages.
The sub-prime market, where lenders provided mortgages with little oversight to borrowers who had little ability to handle the loan, has led to the collapse of a chunk of the U.S. housing market, leading to growing foreclosures and the collapse of companies who lent too freely.
The sub-prime market accounted for about 20 per cent of the U.S. mortgage industry. In Canada, such risker loans make up only about five per cent of the market.
However, the problems in the United States have made getting credit more difficult in Canada as well.