Fear over European banks' exposure to risky government debt stalked markets and harried bank executives on Friday, as unsecured lending between banks evaporated and the cost of secured loans rose. Dwindling trust between the banks is forcing them to rely more and more heavily on the European Central Bank (ECB) to fund their activities, which in turn is spooking investors concerned about the health of the countries funding the ECB.
"The crisis has moved from the sovereign market to the interbank market. When the crisis reaches there it is extremely difficult to come back," said Luigi Buttiglione, a hedge fund manager at Brevan Howard and a former economist with the Italian Central Bank. The head of Europe's seventh-largest bank, Deutsche Bank's Josef Ackermann, said on Friday long-term funding was growing hard to obtain.
"Short-term financing is fine, but the big question is how we can ensure long-term funding," Ackermann told reporters at a conference in Frankfurt. "The willingness of investors to make long-term investments in banks is not very pronounced." A freeze in interbank lending ultimately caused the collapse of Lehman Brothers in 2008, signalling the next phase of the credit crisis, and forcing governments to pump billions of dollars of aid into banks to prevent the system collapsing.
Various indicators of money market stress have already spiked in signs investors are increasingly concerned about preserving their cash. The latest sign of worries about banks' health was the movement of German treasury bill yields, which were heading into negative territory as investors withdrew money from banks and put it in German government short-term paper as a way to preserve cash.
German treasury bills of up to 9 months were bid at rates as much as 0.35 percent, but sellers were asking for prices that would imply negative yields of as low as minus 0.30 percent. Negative yields means investors are willing to pay to keep their money in T-bills, rather than keeping the money in a bank deposit and receiving interest. "When there is panic you don't look at yields anymore, you don't trust parking your money in deposits in the banking system, you want something that protects you cash, even if you pay for it," said ING rate strategist Alessandro Giansanti.
Key euro-priced bank-to-bank lending rates also ticked up - indicating how nervous banks are about lending to one another. That nervousness is pushing them into the arms of the ECB, which is already lending heavily to banks in the wake of the 2008 financial crisis, and can lend more.
After loosening the rules on the collateral it accepts from banks in return for lending them short-term cash, the ECB can potentially lend up to 14 trillion euros to banks. But some are running out of the right types of collateral, and banks are increasingly swapping securities with institutional investors which they can then use to secure more ECB funding, Reuters reported on Thursday.
Banks are currently borrowing just short of 500 billion euros. UniCredit SpA Chief Executive Frederico Ghizzoni urged the ECB this week to increase access to ECB borrowing for Italian banks. New governments in Italy and Greece could buy time, but the risk of a funding crunch intensifying in 2012 remains on the horizon, and a failure to attract investors for the eurozone bailout fund, the EFSF, had knocked confidence, one banker said.
The Markit iTraxx index for credit default spreads for European senior financials has risen to 300 basis points, from 225 at the start of the month. The subordinated financials index has jumped to 540 bps, from 424 at the start of the month. Both indices have doubled since the end of June. Despite the concerns, there are some positive signals. More than a dozen banks signed up to underwrite a 7.5 billion euro rights issue by UniCredit this week, showing they are confident of its health.