Banks snap up dollar loans at central bank auctions

NEW YORK (Reuters) - Banks showed strong demand for U.S. dollars on Tuesday as the U.S., European and Swiss central banks conducted their first auctions of three-month dollar loans, underscoring ongoing credit market strains.

Results of Monday's $25 billion, 84-day Term Auction Facility loan auction held by the Fed showed total bids of $54.8 billion for a bid-to-cover ratio of 2.19, the U.S. central bank said on Tuesday. The bid-to-cover ratio for a Fed TAF auction on February 25 was higher at 2.27, but that was for a 28-day loan.

Concurrent dollar-denominated fund auctions by the European Central Bank and the Swiss National Bank, aimed at easing persistent credit market strains, saw even stronger demand. Banks bid four times the total $12 billion in 84-day funds on offer from the ECB and the SNB.

"Generally, the auction went OK. There were higher cover ratios for the European auctions, which indicate dollar funding needs there were more intense," said Ray Stone, economist at Stone & McCarthy Research Associates in Princeton, New Jersey.

The strong demand reflected the cheapness of the central bank funds relative to wholesale market rates.

The stop out rate for the 84-day TAF loans was 2.754 percent compared with 3-month LIBOR at 2.8 percent.

The weighted average rate at the Swiss auction was 2.65 percent, while the ECB rate matched the Fed's as it was determined by the lowest successful bid in the U.S. central bank's auction.

"The 3-month TAF could be a better deal compared with market rates," said Michael Feroli, economist at JPMorgan in New York.

But it remained to be seen whether the longer-term TAF loans would help bring down market rates.

"The relative small Fed injection of 84-day liquidity is probably not sufficient to materially ease 3-month LIBOR/OIS strains," said Stone.

A wider spread between London interbank offered rates and overnight index swaps, which are anticipated central bank rates, indicates a greater reluctance by banks to lend.

Also on Tuesday, the Fed auctioned $50 billion worth of 28-day TAF loans with a minimum bid rate of 2.01 percent.

The Fed set up the TAF lending facility last December to alleviate funding needs by providing a way, besides the discount window, for banks to tap the central bank directly for funds.

On July 30, the Fed said it would begin offering 84-day TAF loans in addition to 28-day credit as part of measures in coordination with other major central banks to enhance its existing liquidity steps.

To ease liquidity tensions in the future, central banks are considering an idea of accepting foreign denominated collateral, which would allow big banks to raise funds more easily in a pinch.

For example, a bank that did not have a lot of dollar-based collateral but in need of dollar funds could raise money by offering euro-based collateral.

(Additional reporting by Krista Hughes in Frankfurt, John Parry in New York; Editing by Kenneth Barry)