European banks' dollar funding woes feeds worries

Reuters

By Sarah White and Marius Zaharia

LONDON (Reuters) - Soaring costs for borrowing dollars to fund the daily business of Europe's banks is hitting their shares and feeding worries that the continent's spiraling debt crisis could trigger the next funding crisis for lenders.

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Though staying a long way below their 2008 levels when Lehman Brothers collapsed, key indicators such as interbank borrowing rates for dollar funds and the cost of swapping euro interest payments into dollars are on the rise.

The collapse of Lehman sparked a total breakdown in lending markets -- not just in Europe -- which is now a far more remote prospect, traders and analysts said.

But if a repeat of this situation remains unlikely -- especially as euro zone banks under pressure can access funding through the European Central Bank if needed -- the trend is going the wrong way, and could quickly worsen.

"If we see some more, it's going to cause alarm bells," said Philip Tyson, a strategist at MF Global.

The worst-hit UK banks in the stock market -- Barclays <BARC.L>, Lloyds <LLOY.L> and Royal Bank of Scotland <RBS.L> -- were also among those showing some of the biggest spikes in the cost for short-term dollar funds.

The three-month dollar interbank borrowing rate for Barclays and RBS on Friday was among the highest of those used in the daily LIBOR fixing, reaching 34 basis points, up roughly a third from the middle of July.

U.S. banks still found it a lot cheaper to borrow unsecured dollars, with the likes of Citi <C.N> and JPMorgan <JPM.N> quoting the three month rate at 26 basis points.

And the three-month euro/dollar cross-currency basis swap -- which shows the rate charged when swapping euro interest payments on an underlying asset into dollars -- declined steadily throughout the week.

That is also a sign that dollar funds are becoming more expensive. At a negative 91 basis points on Friday, it was close to its lowest level since late 2008, though well shy of a minus 305 bp trough hit that year.

Such fears have battered bank stocks, which fell to their lowest in more than two years on Friday. Most now trade at big discounts to their book value, but markets foresee more pain and still won't pick them up as bargains.

One unidentified euro-zone bank borrowed $500 million in one-week money from the ECB, in the first instance that the central bank's facility was tapped since February, further sparking worries in the market.

For now, funding markets are not panicking. But the ECB's weekly numbers will be closely watched.

"You're going to have to see more signs of banking stress and that some of these facilities are being tapped to see a more marked pickup in the way the (Libor/OIS) spreads are pushing out," Tyson at MF Global said.

(Editing by Douwe Miedema and Will Waterman)