Funding Freeze Fears Haunt Europe's Banks
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Europe's banks are finding short-term financing harder to come by, while fears that the problem may intensify if euro zone policymakers dither has driven their shares sharply lower.
The evidence is most stark in the queue for short-term cash at the European Central Bank (ECB) tenders. Banks also took a hefty 50 billion euros in six-month cash this week, funding reintroduced by the ECB to ease the strains.
Concern that a failure by politicians to get to grips with a debt crisis and the threat it could spread to Italy or Spain, could see the funding squeeze persist into September, causing problems for smaller banks, banking industry sources say.
"Everybody is afraid of another Lehman-style drying out of the money market, because this would hit everybody," a German banker said. "On the other hand it's suicidal to lend money to banks in crisis-hit countries - therefore banks prefer to park the money at the ECB."
These worries combined with other fears around the health of banks and sovereigns to produce a stark sell-off on Wednesday.
Shares in France's Societe Generale fell 15 per cent, Italy's Unicredit slumped 9 per cent and the European bank index lost 6.7 per cent, its worst day since March 2009.
The cost of insuring Italian and Spanish bank debt against default is rising. It is now twice as costly to insure Italy's Banco Popolare, Spain's Bankinter and Banco Popolare di Milano as it was at the start of the year.
"There's clearly signs of stress creeping up in the system as a whole and you can see that in the high euro/dollar basis swaps and spot Libor," said Morgan Stanley strategist Elaine Lin, referring to the money markets where banks go for much of their short-term funding.
Bigger names have not been immune. There has also been a sharp rise in credit default swap (CDS) prices for the likes of Unicredit, SocGen, Royal Bank of Scotland and BNP Paribas as investors remain on high alert for perceived early warning signs.
A lesson learned from the last crisis is that while banks may be too big to fail, that doesn't mean they won't have to be bailed out by governments.
The recent euro zone crisis has also stoked fears about structural flaws in Europe's financial system.
The ECB's use of repurchase operations, or repos, as a major tool of monetary policy meant any of 7,856 banks could go on a credit expansion spree, issuing short-term bonds to finance long-term loans, according to a paper last month by the Peterson Institute for International Economics.
That monetary policy has been undermined by the selective default of Greece's sovereign debt, showing sovereign losses are possible and could intensify liquidity problems.
There is also a wall of refinancing needed in the next two years. 4.8 trillion euros of wholesale and interbank funding expire this year and next for Europe's banks, according to the European Banking Authority (EBA), so any prolonged shutdown would cause deep problems.
In France, Italy and Germany the largest two banks alone need to respectively rollover 6 per cent, 9 per cent and 17 per cent of national GDP in debt during 2011 and 2012, according to the Peterson study. That compares to just 1.6 per cent of GDP for the largest two U.S. banks.
U.S. money market funds, a $2.5 trillion industry that plays a key role in supplying short-term funding to banks, have also retreated from the euro zone in the last two months, compounding the problem for the region's banks.
U.S. prime money fund holdings of euro zone bank securities fell by $38 billion last month after a $58 billion drop in June, a combined withdrawal of more than a fifth, according to a report by JPMorgan.
Others have retreated too. Standard Chartered, based in London but operating mostly in Asia, has withdrawn billions of dollars of liquidity to euro zone banks in the last 18 months, choosing to direct it to Asian clients instead.
The situation is seen as a concern, but not yet severe for most banks. Since the crisis, banks have been attempting to better balance their short-term funding with long-term loans, and top lenders took advantage of benign markets early this year to lengthen the duration of their funding.
But not all smaller banks are so well advanced, and many are heavily dependent on wholesale markets.
Default Risk Jumps
It costs $1.1 million (11 per cent) to insure the debt of Spanish savings bank Banco Pastor for every $10 million of debt held, compared to $565,000 at the start of the year.
And the CDS for Banco Popolare has jumped to 665 basis points from 270 bps at the start of the year, while Bankinter is at 718 bps from 355 bps and Unicredit's is at 363 bps from 188, according to Markit data. SocGen's CDS jumped 65 bps on Wednesday to 325 bps and BNP's rose to over 220, both more than double their level at the start of the year.
British banks, until recently seen as a relatively safe haven away from the euro zone storm, have seen their insurance cost rise as they rely on wholesale markets to fill their funding gaps, with RBS's CDS rising to 305 bps from 213.
But those levels are a long way off those seen in the darkest days of 2008/09.
There are fewer liquidity problems than in 2010 as markets are operating more efficiently, a trading director at a Spanish bank said. "A lot of banks in a lot of countries have liquidity but aren't lending it, they're giving it to the central bank."
Most banks have recently said they are on track with their funding plans - UniCredit said 85 per cent of its 2011 funding was complete by the end of July and RBS said it was 78 per cent of the way through its long-term refinancing, for example, and Morgan Stanley estimated major banks were 65-80 per cent of the way through their 2011 needs.
But they are doing so at a cost. Lloyds and other banks have seen profits hit hard by higher funding and liquidity costs, and that pain looks set to last into next year.
The impact will be felt not just in bank profits, but also on Europe's stuttering economic recovery.
Fabrizio Viola, chief executive of Italy's mid-sized Banca Popolare dell'Emilia Romagna said if costs didn't ease towards the end of the year it would force lenders to cut lending. "There won't be any alternative," he said.