* Mounting sovereign crisis weighs on banking sector
* Funding stress indicators worsen
* ECB providing liquidity, but is there collateral problem?
By Kirsten Donovan
LONDON, Nov 17 Signs of bank funding
stress grew on Thursday as the euro zone sovereign debt crisis
seeped deeper into countries such as France and markets looked
to the European Central Bank to take more dramatic action.
Italian bonds yields held above 7 percent despite more ECB
bond buying while the premium investors demand to hold French
10-year government bonds rather than German Bunds topped 2
With a Fitch Ratings report highlighting concerns over U.S.
banks' exposure to euro zone debt, banks showed little
willingness to lend to one another.
"It's not a liquidity crisis as during the Lehman time
anymore, it is increasingly becoming a credit problem and
there's little the ECB can do about that," said Commerzbank rate
strategist Benjamin Schroeder.
"They can buy time and provide liquidity but the issues have
to be sorted by the politicians. The ECB can't take on risk for
ECB officials have repeatedly said they will not engage in
unlimited, unsterilised bond buying, which would effectively be
the quantitative easing already undertaken by the Federal
Reserve and Bank of England, despite many in the market viewing
it as a necessary step to contain the growing crisis.
It is, however, supplying a large section of the banking
sector with liquidity as other sources of funding dry up.
Gross liquidity in the euro zone banking system is at its
highest since July 2010 at almost 690 billion euros, according
to Morgan Stanley, nearly 300 billion more than requirements.
Weekly borrowing jumped by more than 35 billion euros this
week alone, linked to the rise in the cost of borrowing using
Italian government bonds as collateral in the secured lending
market last week.
Meanwhile, traders said unsecured borrowing was virtually
non-existent with many unable to access even overnight funds.
Banks with excess funds who cannot use the ECB's overnight
deposit facility were lending only to top-rated European banks,
otherwise preferring to look outside the euro zone.
Benchmark three-month Libor and Euribor
rates ticked higher with the spread of three-month
Libor rates over equivalent overnight indexed swap rates -- a
measure of market stress -- around its highest since early 2009.
The premium for swapping euros into dollars rose further
with the three-month cross-currency basis swap around 6 basis
points wider at -136 basis points, the most since the 2008
Commerzbank's Schroeder said that although it looked cheaper
to get dollar funding via the ECB's dollar-swap lines, banks
were not doing this yet.
"Demand for dollars from the ECB has still been fairly muted
in recent weeks, there is still a lot of stigma attached to the
ECB operations," he said.
"The pain threshold has not been reached yet... so we could
still some more widening in money market spreads, especially in
the dollar space, in FRA/OIS for example."
In a sign that ECB funding may soon not be enough, the head
of Italy's UniCredit bank has called on the ECB to increase
access to funding for Italian banks, a source close to the bank
said on Wednesday.
News reports said the request was for a widening in the type
of collateral the central bank would take in return for the
cash, adding to concerns that some banks were running out of
assets to borrow against.
Borrowing from the ECB's overnight lending facility -- which
at 2 percent is costly versus the 1.25 percent charged at
liquidity providing operations -- has been above 2 billion euros
since early October, suggesting funding may not be available
through regular tenders.
Longer-term funding was also close to non-existent, with
just 10 billion euros of senior unsecured debt issued since
July, according to Societe Generale.
Spain's largest bank Santander will modestly boost its
capital by getting investors to exchange 6.8 billion euros of
subordinated debt into new senior notes but analysts said the
exchange terms were not attractive.
"For a national champion like Santander to offer such
punitive exchange terms highlights more than ever the stresses
in the financial system," said Suki Mann, credit strategist at
"(The UniCredit report) is worse for the market than
(Santander's) liability management exercise, it highlights the
huge funding problems the banks have in senior unsecured."