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British banks received a fillip from parliament today, as the Treasury Select Committee called for “more detailed analysis” of the proposal to ring-fence banks’ retail units from the rest of their operations. Banks have criticised the proposal, made by the Independent Commission on Banking, as saddling them with unnecessary costs and restraining their capacity to lend. Signs of a rethink on the proposal sent British banks’ shares sharply higher.
The rally reversed steep declines following Friday’s EU stress test. Although all four of the British banks in the test passed, some of the details that emerged about the banks’ balance sheets spooked investors. In particular, funding costs soared in the test’s “adverse” scenario—which many analysts, including the EIU, think was not nearly adverse enough. The cost of funding for Barclays, for example, rose almost four-fold between 2010 and 2012 in the test, the largest jump in the 90-bank sample. The other British banks in the sample also saw above-average increases in costs, thanks in part to reliance on wholesale funding sources.
Exposure to fickle wholesale markets is one of the reasons cited in favour of erecting firewalls around universal banks’ retail activities. Any new analysis of the retail ring-fence idea should take the implications of banks’ enduring reliance on short-term interbank markets into account.
The Federal Reserve’s “temporary” dollar swap lines with other major central banks are beginning to look like anything but temporary. The facilities were first introduced in December 2007, closed in February 2010, reopened in May 2010, and recently extended through August 2012. Under these agreements, the Fed offers unlimited dollar liquidity to other central banks, which in turn offer the funds to local banks that find it difficult to borrow in interbank markets.
The “re-emergence of strains in short-term US dollar funding markets” was cited by the Fed when it revived the programme last year after its brief hiatus. The recent extension of the swap lines—previously scheduled to expire next month—suggests that officials believe that these strains remain, or may be worsening. But so far the move looks like more of a precaution than a sign of imminent distress. Since announcing the extension on June 29th, no central bank has drawn on the facility (the data is reported weekly, on Thursdays). In fact, the swap lines have not been used since March, when only US$70m was drawn, a small fraction of the hundreds of billions borrowed during the depths of the crisis following the collapse of Lehman Brothers.
The data is noisy and, at times, somewhat contradictory. Yesterday, banks’ use of the European Central Bank’s 0.25% deposit facility fell to its lowest level of the year, with “only” €28.5bn parked at the central bank. This can be seen as a sign of renewed confidence among euro zone financial firms, particularly when it comes to interbank lending—banks may be deciding to lend more to one another, instead of stashing cash at the ECB.
However, on the same day, use of the ECB’s 1.75% marginal lending facility hit a two-week high. The previous high, in late September, proved to be a one-off spike. Sustained borrowing at the current level—last seen during the spring, when fears of a sovereign debt crisis reached a crescendo—would suggest that it is still difficult for some European banks to attract private funds. This warrants watching.
The European repo market has recovered to levels not seen since before the financial crisis, according to the International Capital Market Association. At just under €7bn, the value of outstanding repurchase agreements between European banks at mid-year pipped its June 2007 peak.
But the underlying details, released by the ICMA last week, show that it is not business as usual. Take the collateral pledged by borrowers in return for short-term loans. European government debt fell as a share of total collateral over the past year, and not just the Greek, Spanish and Portuguese debt that have generated the most hysterical headlines. British government bonds were much more reluctantly pledged as collateral and even German debt fell modestly as a share of the total.
Europe’s banking stress tests failed a test of their own on Monday. The cost of euro-denominated interbank borrowing continued to rise, approaching a one-year high.
The Euro Interbank Offered Rate, or Euribor, has risen every day since May 31st, even after the supposedly soothing news on Friday that only seven out of 91 banks failed stress tests conducted by the region’s banking authorities. When it comes to lending to each other, lenders remain wary.
Central banks in Europe began to offer unlimited dollar liquidity today, as part of the recently re-activated swap line with the US Federal Reserve (see yesterday’s post for details). The results of the auctions suggest that short-term liquidity problems may be limited to the euro zone, for now.
The European Central Bank received seven bids for the eight-day, 1.22% fixed-rate funds. It allotted US$9.2bn in total. The Bank of England and Swiss National Bank offered the same terms but didn’t receive any bids.
In response to the “re-emergence of strains in US dollar short-term funding markets in Europe,” today the Federal Reserve reactivated liquidity swap facilities with central banks in the euro area, UK, Switzerland, Canada and Japan. Announced alongside the €750bn support package unveiled by officials in the European Union, banks’ share prices soared.
The Fed’s facility allows foreign central banks to provide dollar-denominated financing directly to local banks. When interbank lending markets seized up during the depths of the credit crunch, the Fed established swap lines with 14 other central banks. At its peak in December 2008, outstanding swaps were worth more than US$580bn, or around 25% of the Fed’s total assets. (This handy primer from the New York Fed, highlighted by Real Time Economics, explains the history and mechanics of the facility.)
The Fed’s facility was launched in December 2007 and closed in February 2010. It will reopen tomorrow and the take-up by central banks will be closely watched. Signs of stress in interbank lending markets suggest that banks are growing more wary of lending to each other, bringing back bad memories from the months following the collapse of Lehman Brothers.
After seizing up during the credit crunch, the market for short-term loans between banks is on the mend. The market for repurchase agreements in Europe grew by 15% in the six months to December, according to the International Capital Market Association.
Although an “important measure of banks’ confidence in lending to each other,” the rebound in repos has not been broad based, the ICMA notes. The recent rise has been driven by a “handful” of institutions, with “continued structural deleveraging” at the bulk of banks.