Libor jitters come at bad time

May 24, 2010

Fears that European banks will be crippled by their sovereign exposure are increasing their borrowing costs. The situation isn’t critical; central banks will act to prevent a report of the post-Lehman crisis. But higher rates won’t help the still fragile recovery gain strength.

It sounds eerily like 2008, when the fear factors were toxic mortgages and the collapse of Lehman Brothers. A collapse in liquidity made the funding market for banks almost dysfunctional. Debts were rolled over at ever higher costs and shorter maturities.

Once again, there is a widening spread between Libor, the rate banks pay to borrow from each other, and overnight index swaps (OIS), the governments’ cost. European banks are having the most trouble. U.S. money market funds, which hold more than $500 billion of euro zone financial assets, may be cutting exposure. There are also worries that U.S. banking reform will remove the implicit government guarantee for some big institutions there.

But as yet there is little chance of a repeat of the post-Lehman crisis. To start, while the implied Libor-OIS spread has quadrupled since April to 46 basis points, it is far below the September 2008 peak of 192 basis points.

Also, regulators have learned from 2008′s horror show. The European Central Bank has pumped hundreds of billions of extra euro-denominated funding into the banking system and revived emergency dollar funding lines.

These lines have not been widely drawn on, suggesting the situation is not critical.

But there’s little room for complacency. Concerns over euro zone governments’ finances are likely to persist — and could spread. Banks globally need to refinance about $7 trillion of debt in all maturities by the end of 2012. A sustained rise in funding costs would squeeze weaker players.

The pain could spread beyond the banks. European borrowers current enjoy some of the easiest monetary conditions in history, according to an index compiled by Nomura, thanks to low government bond yields and a falling euro. Higher bank rates would gradually trickle through to borrowers of all stripes, raising the odds on a double-dip recession.

Comments

You really feel there could be double-dip? What are implied easing and continued hold on rates – BoE met this week to keep at 0.5%

Posted by oscarwilde | Report as abusive
 

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/