NEW YORK Short-term U.S. dollar-funding rates were strained on Tuesday as euro zone banks increased borrowing at the European Central Bank to the highest level in two years, and U.S. bank debt insurance costs rose as fears increased over their exposure to the region.
Bank funding pressures have increased as euro zone leaders have failed to offer solutions to a dramatic rise in the borrowing cost for European countries, with fears of further contagion spreading to core nations including France.
Investors have been accelerating sales of European bonds as U.S. money fund investors also pull back on making unsecured short-term loans to banks in the region, which has exacerbated funding pressures.
"It's really down to the euro zone solution, people are looking for an actionable plan," said Jim Lee, head of short-term strategy at RBS Securities in Stamford, Connecticut.
Bank borrowing at the ECB's weekly offering of unlimited seven-day loans rose by 17 billion euros to 247 billion euros on Tuesday, highlighting the growing difficulty of sourcing funding from interbank markets as the region's debt crisis escalates.
U.S. money funds reduced loans to European banks by an additional 9 percent in October, and increased their holdings of short-term U.S. Treasuries, Fitch Ratings said in a report on Tuesday. The funds have reduced loans to Europe by 42 percent since the end of May.
On Wednesday, the ECB will hold its regular seven-day dollar tender, with markets keen to see if more banks than the two which borrowed $552 million last week, bid for funds.
Investors will also be closely watching the ECB's planned 84-day offer of dollar loans on December 7 to see if there is an increase in the takeup by European banks.
The cost of obtaining three-month dollar loans by swapping euros in the foreign exchange market is approaching levels that would make it cheaper to use the ECB's facility, said Lee of RBS.
Three-month cross currency basis swaps, which measure the cost of swapping euros into dollars, edged back from the previous session's extremes but remained within sight of the most expensive level since the 2008 financial crash at around -138 basis points.
In one potentially positive sign the International Monetary Fund on Tuesday beefed up its lending instruments and introduced a new six-month liquidity line, throwing help to countries at risk from the European debt crisis.
U.S. banks are also coming under pressure as investors fear their exposure to large banks in France and the UK, which are in turn highly exposed to peripheral European debt.
Spain's short-term borrowing costs hit a 14-year high on Tuesday, with average yields on Spain's three- and six-month treasury bills soaring by around 2 percentage points, after a resounding election victory for the center-right People's Party did little to soothe investors' nerves.
Credit default swap costs for U.S. banks including Morgan Stanley and Goldman Sachs increased to their highest levels since early October as fears over European exposures increased.
Morgan Stanley's CDS costs were last up 12 basis points to 509 basis points, or $509,000 per year to insure $10 million in debt for five years, according to data by Markit. Goldman's swaps increased 16 basis points to 406 Basis points.
Three-month dollar Libor rates also increased for the 102nd consecutive session, fixing above 50 basis points for the first time in over a year. The rate has doubled from 0.24 percent in July.
(Additional reporting by William James in London; Editing by Leslie Adler)