LONDON, Nov 18 (IFR) - It's looking increasingly
likely more European banks will be forced to tap the European
Central Bank's US dollar facility, as stress in the cross
currency basis swap market has once again become acute this
Few banks have opted to tap the ECB's dollar facility so
far, but a combination of foreign investors continuing to shun
European banks and swaps markets fast becoming prohibitively
expensive may soon spur a larger drawdown at the ECB's weekly
unlimited dollar auction.
"We are more or less at levels where banks are indifferent
about going to the ECB or the FX market for dollar funding. Over
the last few days spreads have widened dramatically in the FX
market, making dollar funding more expensive. As a result, banks
may well want to start tapping the ECB dollar facility more,"
said Pavan Wadhwa, global head of rates strategy at JP Morgan.
The dollar funding issues for European banks have been well
publicised over the past few months. Fearful of the worsening
Eurozone crisis, vital sources of dollar liquidity like US money
market funds reduced their exposure to European banks in the
Many European banks reacted by selling dollar assets and
entering into secured funding transactions to alleviate their
funding stress. At the same time, coordinated central bank
action announcing the introduction of new dollar swap lines in
mid-September helped to significantly ease markets.
However, signs of dollar funding stress have returned over
the past fortnight, as the Eurozone crisis once again stepped up
a gear. The three-month EUR/USD basis swap is currently trading
at 129bp below Euribor, compared to around 103bp below three
According Wadhwa, the cost for European banks of getting
dollars in the open market has traditionally been in the region
of five to 20bp lower than going to the ECB (which charges 100bp
over the Federal Funds rate). Now, the increased stress in the
market is starting to make it economically unviable for European
banks with dollar funding shortfalls to rely on the open market.
"The way that the market is going, pressure is increasing
for people to start tapping the ECB dollar line, both because
the FX forward markets and the cross currency markets are
drifting in the wrong direction making it more expensive to roll
funding in the open market through the FX forwards, and because
the banks themselves in Europe are under increased funding
pressure as time goes by," said Nick Hallett, head of cross
currency swaps at Barclays Capital.
There is a stigma attached to tapping the ECB's facility,
and so banks try to avoid doing so if possible, despite the
auction process being anonymous. Use so far has been limited:
this week two bidders took down USD552m at the auction, compared
to four bidders taking USD395m the week before. Participants
believe the basis swap market may have to get even more stressed
before there are significantly more bids.
"Banks will only go to the ECB if they are forced to. I
think the basis swap market will have to get around 25bp more
stressed before people abandon the market completely and start
going to the ECB," said Wadhwa.
Meanwhile, central banks will likely continue to monitor the
situation. Some market participants have suggested the ECB may
look to lower the rate it charges for tapping the facility, with
some observers estimating a 50bp cut would attract far more
banks and alleviate the stress in the market.
Participants believe central banks have already shown their
willingness to act, following the unprecedented announcement
from the Bank of England, European Central Bank, Bank of Japan,
Swiss National Bank and Federal Reserve in September of offering
three three-month unlimited dollar auctions.