European credit squeeze raising risks: James Saft

By James Saft

LONDON (Reuters) - Europe, suffering a credit squeeze which shows no signs of easing, is facing real risks, both to growth and financial market stability.

Real estate in the euro zone is not in distress but European banks have been hard hit by their adventures in American housing and structured finance, leaving them less to lend at home.

Securitization of loans, which had been a burgeoning source of cash for Europeans wanting money for housing, business investment or consumption, has also slowed drastically.

And while a European credit crunch is probably going to be less severe than its U.S. twin, the longer difficult conditions persist, the higher the chances of either a European Northern Rock NRK.L or a substantial hit to growth.

Stricken British lender Northern Rock, now seeking a buyer, is estimated to have borrowed about 25 billion pounds from the Bank of England since it was forced to turn to it for funds after being unable to raise finances in wholesale markets.

Two month interbank rates in euros, an indicator of the price at which banks can borrow from one another on the money markets, hit their highest level in 6-1/2 years on Tuesday at 4.63 percent, compared to a 4 percent benchmark European Central Bank rate.

This reflects European banks' fears of a temporary cash squeeze at the year-end period, but is fundamentally the result of too little bank capital and too many bank liabilities.

"The longer the money market remains closed, the longer the securitized debt market remains closed, the higher the probability we will see ugly effects on the European economy," said Jochen Felsenheimer, head of credit strategy at Unicredit (HVB) in Munich.

Bank lending conditions for both firms and individuals in Europe are now substantially less generous, according to Michael Hume, economist at Lehman Brothers in London.

Hume compiles a credit channel conditions index measuring bank capital conditions, lending terms and lending growth. This showed credit conditions slumped in September, falling by nearly 20 percent and the worst monthly fall in more than 4 years.

Unsurprisingly, with banks only able to borrow from each other at more than a half a percent above ECB rates, they are charging more to clients too.

It is important to note that the euro zone is much more dependent on bank lending than the U.S. Only about 20 percent of U.S. growth is financed directly from banks, according to Lehman estimates, as opposed to 60-65 percent in the euro zone.

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Securitization volume has fallen off a cliff around the world and in the euro zone.

Thus far this month, only about 2.2 billion euros in securitized deals were done in the euro zone, according to Unicredit data, as against about 26 billion in October and about 50 billion in June, before the market disruption began.