Saturday, December 17, 2011

Severe dollar funding constraints will push EU banks out of US markets

The tightness in dollar funding continues to be a major problem for a number of EU banks. Much of it is driven by US money market funds not rolling their commercial paper (CP) holdings issued by eurozone banks. As CP matures, European banks have to find alternate sources, which is proving to be difficult.
Yahoo Finance: "It is utter madness ... When we see big names paying 300 basis points over overnight rates for dollars you know something is wrong," said the head of money markets at a bank in London, who asked not to be named.
The non-US financial institutions' commercial paper outstanding continues to dwindle:

This demand for term dollar funding keeps putting upward pressure on interbank lending rates as banks want to charge increasingly more to part with dollars for longer than overnight:

The ECB has responded by tapping the Fed Liquidity Swap Facility this week in the amount not seen since 2009 in order to provide dollars to numerous eurozone banks.

Many European banks will be forced to change their business models.  This inability to raise dollars will severely constrain their activities in the US, making it increasingly difficult for them to lend to US corporations or buy illiquid US assets.  Even if the situation in the eurozone improves, these banks will be loathe to add dollar assets to their balance sheets because of potential funding risks in the future.

In many instances they will also be constrained from lending in Asia and the Middle East, where dollars are often preferred to euros because of trade with the US.  Without access to dollar funding, European banks will shift their focus to Europe, creating new opportunities for US (and in some instances UK) and Asian banks. Banks like JPMorgan and HSBC will be clear winners and increase market share because of their access to dollars.
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