Bank funding stress threatens Europe credit crunch

LONDON (Reuters) - The risk of a credit crunch in southern Europe is rising as banks face stress in their medium- to long-term funding, forcing some to shrink their lending, analysts said on Monday.

European banks were rocked last week by concern about a squeeze for short-term funding, with tougher and more costly financing and a retreat by U.S. money market funds prompting lenders to turn to the European Central Bank (ECB) for more cash. France's banks were hit particularly hard.

"Bank funding remains a key source of risk for bank earnings, ability to lend and a drag on economic recovery ... the risks of a credit crunch in southern Europe are rising," said Huw van Steenis, analyst at Morgan Stanley.

Morgan Stanley estimated Europe's leading banks have issued about 90 percent of their term funding needs for this year on average, and have significant liquidity pools and European Central Bank funds to help.

But it said many European banks have struggled to raise long-term funding in the last three months, and even when markets re-open the costs are likely to be high.

A funding "circuit breaker" is needed to reduce the stress and the creation of a temporary bank liquidity guarantee program underwritten by the European Financial Stability Fund (EFSF) could strengthen confidence and encourage liquidity, van Steenis said in a note.

The speedy deterioration in funding markets -- which were a lead indicator of pressure points during the 2007/08 financial crisis -- has raised fears about the knock-on effect on fragile economies.

"While unlimited provision of ECB liquidity to euro zone banks means that a funding crisis is unlikely, constraints on private sector access to financing will undermine banks' provision of credit to households and businesses and could derail an already weak recovery in Italy and France," analysts at CreditSights also warned.

Europe's bank stocks were near flat in early Monday trading, after a roller-coaster ride last week, when a slump by Societe Generale <SOGN.PA> led the index to a two-year low before stabilizing at the end of the week.

(Reporting by Steve Slater; Editing by Hans-Juergen Peters)