May 5, 2010 / 9:12 PM / 9 years ago

US bank cost may raise on money fund move-Barclays

NEW YORK, May 5 (Reuters) - U.S. bank borrowing cost could spike higher in the coming weeks, if money market mutual funds were to put more cash into Treasury bills and repurchase agreements rather than bank commercial paper, Barclays Capital said on Wednesday.

The three-month London interbank offered rate (Libor) for banks USD3MFSR= to borrow dollars from each other could rise to 0.60 percent, about a quarter percentage point higher than current level, according to Barclays’ money market strategist Joe Abate.

Libor is a rate benchmark for about $370 trillion in financial products worldwide.

Three-month dollar Libor has risen steadily since March, as unsecured lending to some European banks has been reduced.

“Given the importance of money funds in providing bank funding, we believe a modest reallocation away from bank paper and toward repo and bills could have a significant effect on Libor,” Abate wrote in a research note released on Wednesday.

The $2.9 trillion money market fund industry is a key source of short-term financings for banks. Their reluctance to invest in commercial paper issued by banks and other companies in the wake of the collapse of Lehman Brothers exacerbated the global credit crisis in September 2008.

A year-and-a-half later, Greece’s debt problem has revived fears of another worldwide credit event.

This could result in money market funds will reallocate between $100 billion to $200 billion of their holdings in bank securities in favor of less risky T-bills and repos, Abate said.

Such a risk-aversion move is reinforced by implementation of tighter regulatory requirements on money market funds at the end of May, he added.

“But now that risk aversion has picked up, money funds may have a stronger motivation to reallocate their assets more quickly - first, as a flight to quality into repo and bills and secondly in preparation for a possible increase in prime money fund redemptions,” Abate said.

Back in September 2008, prime money funds — those used by institutional investors — sold $315 billion in commercial paper in a few weeks. Commercial paper, which accounted for 45 percent of prime fund assets, fell by 40 percent, he noted.

While prime fund balances have held steady in the light of the Greek debt crisis, Abate cautioned large investors “could quickly get unnerved and begin redeeming their money fund holdings.”

Reporting by Richard Leong

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