August 18, 2011 / 6:46 PM / 8 years ago

Funding fears grow on Fed scrutiny of Europe banks

* Some European names face higher borrowing costs

* Funding stress may intensify without short-term solution

* Three-month dollar funding costs highest since April

* N.Y. Fed, Treasury in touch with banks on European risk (Adds market action, Treasury/Fed contact with banks)

By Richard Leong and Ana Nicolaci da Costa

NEW YORK/LONDON, Aug 18 (Reuters) - Some European banks are being forced to pay more for access to short-term U.S. dollar loans as fresh fears surface over the euro zone fiscal crisis spreading through the financial sector.

Growing nervousness about another global financial crisis unleashed a massive sell-off in stocks on both sides of the Atlantic on Thursday. Anxious investors piled into safe-haven gold XAU=, Swiss francs CHF= and U.S. Treasury bills US1MT=RR, whose rates turned negative. See [MKTS/GLOB]

The latest wave of anxiety came after The Wall Street Journal reported the Federal Reserve is taking a closer look at the U.S. units of Europe’s biggest banks on worries that the region’s debt crisis could spread to the U.S. banking system. [ID:nL5E7JI0QY]

The report came a day after an unidentified euro zone bank borrowed $500 million in one-week dollars from the European Central Bank. It was the first time a euro zone bank tapped the ECB for such funding since February.

Short-term money markets showed further signs of bank stress emanating from Europe’s fiscal strains. The benchmark for unsecured dollar loans between banks, three-month Libor LIBOR, rose to its highest in 4-1/2 months, the latest in a series of such peaks.

Of the 11 European banks that contribute to the calculation of Libor, six are paying above the daily fixing, while the rest are paying below that level.

Foreign banks also reduced issuance of U.S. commercial paper in the latest week as investors became more anxious about the European debt crisis, Federal Reserve data released on Thursday suggested. [ID:nN1E77H0RN]

“A lot of flows have not returned to the interbank market. Most investors are not very comfortable right now,” said Mike Lin, director of U.S. funding at TD Securities in New York.

London interbank offered rates for three-month dollars rose to 0.29778 percent from 0.29589 percent on Wednesday.

UK banks Barclays (BARC.L) and Royal Bank of Scotland (RBS.L) said they paid 0.3400 percent for three-month dollars on Thursday. It was the second-highest rate paid, just behind the 0.34500 percent Japan’s Norinchukin said it paid

In the meantime, top French banks have been under intense scrutiny due to their high exposure to peripheral debt.

Societe Generale (SOGN.PA) and Credit Agricole (CAGR.PA) were paying for three-month dollars at 0.32500 percent and 0.33000 percent, above Thursday’s fixing.

But BNP Paribas (BNPP.PA) said its borrowing cost on three-month dollars was 0.29500 percent, slightly below Thursday’s fixing.

The Libor data suggested not all European banks are being lumped into the same risk group, though that is cold comfort for a market where strains are running high.

Scandinavian banks, for example, could obtain three-month dollar loans at anywhere from 0.15 percentage point to 0.30 percentage point cheaper than French banks, analysts said.

Responding to the report in The Wall Street Journal, William Dudley, the president of the Federal Reserve Bank of New York, said the Fed is “always scrutinizing” banks and that it treats U.S. and European banks “exactly the same.” [ID:nN1E77H052]

The New York Fed and U.S. Treasury have been in close contact with all U.S. banks that have European exposure, urging them to review all levels of counterpart risk they have with European banks, a source familiar with the Treasury and N.Y. Fed talks with the banks said.

The risk premium on two-year U.S. interest rate swaps over two-year Treasuries recorded its biggest jump in 1-1/2 weeks to 26.75 basis points on Thursday. The two-year swap spread USD2YTS=RR grows with counterpart fears.

There is deepening gloom over the prospects of solving the euro zone debt crisis after a French-German summit earlier in the week did little to soothe investor concerns that the problems could spread from weaker countries to the heart of the financial system.

Markets “are concerned about a potential intensification of financial stress,” said Philip Tyson, strategist at MF Global. “The stress in the peripheral markets is bound to return at some point because we haven’t seen any permanent solution.” (Additional reporting by Rachelle Younglai in Washington; Editing by Dan Grebler)

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