By David Oakley in London
Published: December 19 2010 20:02
Mounting concerns over the eurozone have forced the cost of swapping euros into dollars to the highest level since May, sparking fears that European banks could run into funding difficulties as they need the US currency to repay loans.
The costs have been pushed higher because of the strong demand for the dollar, seen as a haven amid the ongoing debt crisis in the eurozone, and the reluctance of some US banks to lend to European banks, dealers say.
This is reflected in the so-called basis swap market, where an investor can exchange euros for dollars over a period ranging from one day to 50 years.
Although the strains are nowhere near the levels seen at the time of the collapse of Lehman Brothers in September 2008, strategists warn a fresh crisis could blow up next year because of the funding gap.
European banks currently have an estimated funding gap of about $500bn, which means they have to raise this amount from the markets to fund dollar loans, meet swap arrangements and pay for trading book transactions that require the US currency. The dollar funding gap was estimated at more than $1,000bn at the time of Lehman’s bankruptcy.
The Institute of International Finance, which represents more than 400 financial services groups around the world, warned in a report last week that some European banks appeared to be facing dollar funding pressures.
The European Central Bank said this month in its financial stability review that “the dollar funding situation of European banks continued to be under scrutiny”.
The effects of the end of the year – when banks are more reluctant to lend to rivals as they want to protect their own balance sheets – have also pushed up the costs of swapping euros for dollars. However, dollar swap lines opened up between the ECB and the US Federal Reserve have eased pressures.
The flip side is that it has become cheaper for European banks to issue debt in the US currency because they can swap back into euros for less. European bank issuance in dollars has risen to $150bn so far this year, a four-year high, according to Dealogic, the data provider.
Non-financial companies around the world have also flocked to the US to issue dollar-denominated bonds to lock in the cheaper swap rates.
The basis swap rate to exchange euros for dollars over three months, the benchmark rate, fell to minus 60 basis points at the end of last week. That means banks would pay an extra 60bp premium for the swap.
Euro basis swaps hit a low of minus 300bp on September 30 2008, when the market in effect shut down.
Copyright The Financial Times Limited 2010.
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