Interbank rates up on bank write-down fear

While some gauges of market strain such as the three-month premium paid over anticipated central bank rates held steady, interbank lending remained sparse and limited to very short maturities, traders said.

Riskier assets such as equities rose earlier on Monday after a meeting of finance ministers from the world's 20 leading economies piled pressure on European leaders due to meet on Sunday to decisively tackle the two-year debt crisis.

German officials played down expectations, with a government spokesman warning against unrealistic "dreams" the summit would deliver a definitive plan. German Finance Minister Wolfgang Schaeuble also cautioned against unrealistic hopes.

Euro zone policymakers' expected measures to try and solve the debt crisis are likely to see banks take a hit, and fears about the damage this could inflict on the financial system have driven market volatility since July.

Schaeuble made clear at the weekend that Greece's private creditors would have to accept bigger losses on their holdings of Greek debt, piling on pressure on banks.

In the unsecured lending market, London interbank offered rates for three-month euros rose to fresh nine-week peaks of 1.50750 percent . The equivalent Euribor rate was also higher as banking sector tensions outweighed a glut of excess liquidity swishing in the system.

"You have some bilateral trades going on in very small amounts and no term lending because there's no trust among banks. Confidence and trust will have to come from the long end (of the interbank market)," a trader said.

"Regaining trust and confidence among banks will take a long time even if there's a fantastic set-up and framework from policymakers by the beginning of December."

Efforts by euro zone leaders to convince banks to accept "voluntary" writedowns of up to 50 percent on their Greek debt, from around 21 percent when a second bailout plan for Greece was agreed in July, were also rattling money markets.

European Central Bank policymaker Juergen Stark warned that changing the terms of investors' bonds in the euro zone made the bloc look like a risky investment proposition.

"Moving away from a 21 percent haircut makes sense because we're not in the same market conditions than in July but the problem is where would you put the trigger," said Patrick Jacq at BNP Paribas.

"It's worrying because for banks it means more significant writedowns and could create problems for some investors."

In a further sign of banks' reluctance to lend to each other, overnight deposits at the ECB which pays a lower interest rate rose to 136 billion euros from 123 billion the previous day.

Highlighting the extreme uncertainty over European banks' funding needs, forecasts in a poll for the ECB's first one-year tender in almost two years, due to be held next week, ranged from 10 billion euros to 150 billion euros.

Demand for the bank's seven-day loans is also expected to remain high, though slightly off last week's allotment of 204 billion euros. Money markets are already well overstocked with ECB funds, which have been augmented by the re-introduction of three-month and one-year funds in an effort to ease money market strains and lower interbank lending rates.

Excess market liquidity stands at 229 billion euros, according to Reuters calculations, just below Friday's level, which was the highest since the end of June last year.

Copyright Reuters, 2011