Monday, December 12, 2011

Serious financing problems at EU banks

There is a serious funding problem with EU banks and it is not getting better. This is the key problem for the Eu and we will have to come to grips with the choice of whether this is a liquidity or a solvency issue. We already know the answer  - solvency. All that bad debt is not going away and investors have choices.

Three month euro/dollar basis swaps have moved from inside -50 bps to over -150 bps before the announcement of the currency swap arrangement between central banks. It is still had high levels over -100 bps. The three month Euribor-OIS spread which is another measure of bank risk is still at approximately 80 bps when most of the year it has been between 20 and 35 bps. The ECB lending to banks is also soaring to above 8 billion euros. There have been moves to relax collateral requirements and cutting initial margin from 20 to 12 percent. The ECB is also allowing more term funding.

The issue is whether the ECB actions are too late. Of course, there can be improvement in the fiscal situation but a European slowdown will only make matter worse and cutting rates another 25- 50 bps will not solve the problem. Banks need recapitalization and it will not come from private sources.

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