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Why Europe's Banks Are on a Borrowing Binge

Euro bills
Euro bills

The ECB reports that for two nights in succession there has been a spike in the emergency cash it’s been asked to provide Euro Zone banks.

Banks have an automatic right to seek overnight loans from the ECB if they discover an imbalance on their books at the end of the business day and need liquidity.

The last time requests for overnight funds totaled more than 10 billion euros was in the run-up to the Lehman crisis, peaking at 28.7 billion euros on June 24, 2009. More recently, it’s been around one billion. But around 16 billion euros was borrowed both Wednesday and Thursday nights this week.

The immediate question is whether a Euro Zone bank in trouble. The market does not believe that to be the case.

41669198

June 2009 $28.7 Billion
Recently $1.2 Billion
Wednesday $15.8 Billion
Thursday $16.0 Billion

Traders I’ve spoken to point to the fact that there is no sign that Europe’s credit markets are beginning to seize-up as they did last spring, with banks worrying about each other’s counter-party risk. That’s evident from the fact that there is no spike in LIBOR, the interest rate at which banks borrow unsecured cash from each other on London's wholesale market.

"It’s completely out of the blue," Arturo de Frias at Evolution Securities tells me. "The banks have reported earnings and no one complained about experiencing issues over funding. But if you think about the funding pool of the entire banking sector, it’s still only a drop in the ocean."

3M US Dollar LIBOR, which is the most sensitive, is still down on the session. To me, this does not indicate that there are funding problems in the European market. Yields continue to rise on Portuguese debt, but continue to be ignored by the general market.

The most common explanation for the spike is that "fat fingers" are to blame. In other words, that one bank, perhaps, typed in too low a figure on its request to borrow at the ECB's weekly funding round on Tuesday. So it’s now making up the gap with daily borrowings.

Headline figures from the ECB’s weekly tender support the idea that a regular borrower may have been absent. Only 137 billion euros was borrowed on Tuesday, 19 billion less than last week and 23 billion less than the Reuters consensus.

If the fat fingers theory is correct, the spike will appear again in tonight’s borrowing figures, released just after 3am ET Monday.

Barclays Capital is alternatively speculating that the ECB might have forced one player heavily dependent on its loans to switch to marginal lending, as part of a wider effort to ‘clean’ the system.

But James Chappell at Olive Tree says that would surprise him. "For banks to be made entirely reliant on more expensive, overnight funding would create greater systemic risk and possibly panic in the market," he tells me. "The ECB is more focused in trying to get EU governments to buy their own peripheral debt as a way to reduce reliance on it as a lender of last resort."

Perhaps the biggest takeaway is that Euro Zone’s banks still borrowed 137 billion euros at the ECB’s weekly tender. "It’s indicative of how many individual banks have loans that exceed deposits," argues Chappell.

"Under normal circumstances that would make them structurally dependent on wholesale funding from the market. But the stress that still exists in the market means they are totally locked out from wholesale funding if they’re located in Greece, Portugal and Ireland."

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