Thursday, August 18, 2011

European Bank Liquidity

Starting last week we started seeing questions surfacing regarding the liquidity needs of European banks as a result of the volatile swings in the stock markets (if bank stock equity goes down they face the need to raise more capital) and potential opening market attacks on French banks (which I find hard to believe resulted from misinterpretation of a fictional series in a French newspaper). On August 10th, ECB overnight lending facility use jumped $5.75 billion dollars (4.058 billion euro), although it could have been from timing issues as banks awaited the arrival of ECB six month funds.  It was noted last week that the LIBOR-OIS (bank credit risk) spread with EURUSD basis swaps was widening but differently than it did in 2008.  The LIBOR-OIS was due to a rise in the LIBOR which would indicate the gap is being driven by liquidity measures, but the EURUSD basis swap was increasing on the short end implying near term caution rather than systemic risk.  Short term wholesale funding problems are magnified when access to long term funding in senior unsecured debt markets become more independently difficult for banks.  Nomura  noted the net stable funding ratio shows CASA, SocGen, Bankia, UniCredit, Commerzbank, and Intesa with the lowest ratios, but no European banks have reserve problems and, as of last week, no European bank had gone to the ECB for USD liquidity.  In relation to the short term liquidity functions last week, it also appeared that the peripheral eurozone countries were having a collateral crunch as well as a credit crunch.

Yves Smith at naked capitalism noted this week that mid-tier banks are finding it harder to get funding in interbank markets, that five year CDS of eurobanks are trading wider than they did in 2008m U.S> money market funds have cut back on exposure to European banks, eurobanks are have a harder time borrowing euro from the ECB to swap for US dollars, and the eurozone is not prepared for any large scale recapitalization of banks program.

On Wednesday of this week, one European bank borrowed $500 million, which was an unusually large amount for one bank, from the ECB in US dollar liquidity for the first time since February.  This would indicate it was probably a larger European bank under temporary stress.

Today, the Wall Street Journal wrote that the New York FED is meeting with the U.S. offices of large European banks to gauge their vulnerability to to escalating financial conditions and potential funding difficulties as U.S. branches of foreign banks became net borrowers of dollars from their overseas affiliates for the first time in a decade.  The New York FED President, Dudley, was quick to publicly state this was just a standard FED review.

On this Wednesday, excess liquidity in money markets actually rose 167 billion euro as Euribor lending rates went down.

This has led to a renewed discussion, involving nerves, noise and funding fears, of what level of funding stress European banks may or may not be facing.  While there are indications of stress in the wider markets, the spread on the three month Euribor rate and the overnight  index swap OIS rates has widen but nowhere near the post-Lehman 2008 peak.  What is interesting is the spike is from a drop in the OIS rate not the Euribor, which implies banks think the swap rates will drop and liquidity improve.  This would indicate the situation is not one of extreme stress, but an evolving situation which requires watching.

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