Banks in Britain, Spain and Ireland that have relied on the European Central Bank for low-cost funding will have to pay more as it tightens lending rules.
ECB President Jean-Claude Trichet, concerned that some banks were abusing its willingness to make loans backed by securities most investors won't accept, said Thursday the central bank will increase the so-called “haircut” on securities used as collateral for loans to 12 percent from as little as 2 percent, meaning it will lend just 88 percent of their value.
“It's a call to discipline from the ECB,” said Tomas Varela, chief financial officer at Banco Sabadell, Spain's fourth-largest bank, which holds about 5 billion euros ($7.2 billion) of securities that will be worth less after Feb. 1, 2009, under the new ECB rules. “It's a signal to the financial industry to start opening up more normal avenues of liquidity.”
The ECB, which lent 467 billion euros last week to banks with operations in the 15-country euro area, accepts a broader range of collateral for loans than the Federal Reserve or the Bank of England, including bonds with credit ratings five levels below AAA and asset-backed securities. This leeway prompted some firms to create bonds specifically as collateral for ECB borrowing.
Cutting dependence:
“It is a bit like a drug and they don't want the banks to become dependent,” said Neil Smith, a Dusseldorf-based analyst at WestLB. “There have been concerns the facility is being exploited, and the ECB wants the banks to start finding alternative ways of funding their business.”
“People are waking up to the fact that the support scheme is getting rather bigger than the ECB is comfortable with,” Leigh Goodwin, an analyst at Fox-Pitt Kelton in London said.
Spain's share of ECB borrowing increased to 10.8 percent from 4 percent a year ago, according to Bank of Spain data. Spanish banks borrowed a record 49.4 billion euros from the ECB as of last month.
Credit-default swaps on the subordinated debt of Spanish and Irish banks led a rise in the cost of protecting banks from default.
Contracts on Banco Bilbao Vizcaya Argentaria, Spain's second-biggest bank, rose 10 basis points to 180, the highest in more than five months. Banco Santander, Spain's biggest lender, increased 9 basis points to 186. Bank of Ireland rose 7 basis points to 380 and Allied Irish Banks rose 3 to 327.
Credit-default swaps on the Markit iTraxx Financial index of subordinated debt for 25 European banks and insurers jumped 9 basis points to 187, the highest since April 1, according to JPMorgan Chase & Co. prices.
Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase indicates a decline in the perception of credit quality.
A basis point on a credit-default swap contract protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year.
“This is clearly bad news for the profit and loss of banks, especially Spanish and Irish-based ones, that have retained asset-backed securities,” said Luca Jellinek, head of interest-rate strategy in London at Royal Bank of Scotland. “ECB financing is a significant feature of their balance sheet.”
ECB lending to Irish banks more than doubled to 44.1 billion euros in the year through July, the central bank in Dublin said. About half goes to Dublin-based units of lenders from outside Ireland, according to Eamonn Hughes at Goodbody Stockbrokers.
HBOS, with a unit in Ireland, is among British banks that borrowed from the ECB, said Mamoun Tazi, an analyst at MF Global Securities Ltd. in London.
Central banks made borrowing easier after losses from subprime mortgage defaults in the U.S. caused credit markets to seize up worldwide. Banks have lost or written down $509 billion since the credit crisis began last year, with Europe accounting for $230 billion.
“The losers are the banks retaining bonds to raise cheap collateral, now the cost will be higher,” said RBS's Jellinek. “The winners are the rest of the euro system whose collateral has been edged out.”
Europe faces recession, Fosler says
SINGAPORE - Bloomberg
The U.S. economy is “stagnant” and Europe is falling into a recession, the Conference Board said Friday, warning that central banks won't have much room to cut borrowing costs amid elevated prices.
“This is a period of rolling adjustments, that goes from sector to sector, that will keep the U.S. growth rate low in the 1 percent-to-2 percent range for the foreseeable future,” said
Gail Fosler, president of the New York-based group known for its consumer confidence survey.
The euro slumped to an 11-month low against the dollar Friday after European Central Bank President Jean-Claude Trichet said Thursday the economy is “weak.”
The U.S. government needs to start using more of its money to support markets and stem a burgeoning “financial tsunami,” said Bill Gross, manager of the world's biggest bond fund.
Risks to economic growth are intensifying globally even as the U.S. economy stabilizes amid productivity gains, Fosler told a conference in Singapore Friday. Australia's economy is slowing rapidly and China is seeing the most pronounced signs of a slowdown since the Asian financial crisis a decade ago, she said.