European Banks Facing Larger Funding Needs Than US Banks
The Bank for International Settlements sheds some light on the funding problems banks face as a result of the subprime-induced financial turbulence, in its latest Quarterly Bulletin. The BIS suggests European banks face tougher dollar funding challenges than their US counterparts.
In a paper International banking activity amidst the turmoil, Patrick McGuire and Goetz von Peter use BIS international banking statistics to trace the longer-term developments in the interbank market and conclude with an analysis of
banks’ bilateral interbank exposures.
The paper includes some striking data and illustrations of the explosive growth of bank liabilities, particularly of lending to non-bank borrowers in the US.
“Growth in credit to non-bank borrowers contributed greatly (39%, or
$10 trillion) to this expansion. This development coincided with the rise of the
structured finance industry, the expansion of banks’ proprietary trading
activities and the growth in their hedge fund prime brokerage business. Banks’
claims (primarily loans) on non-bank entities increased from less than $4 trillion
at end-1999 to $14 trillion by the end of 2007, with claims on non-bank
borrowers located in the United States, the United Kingdom and the Cayman
Islands accounting for 21%, 16% and 6% of these positions, respectively. “
It also highlights the central role UK banks have assumed:
Roughly one quarter of the overall increase in banks’ total international
assets since end-1999 has been booked by banks located in the United
Kingdom.
The authors also point up the stark contrast between European and US Banks:
“US banks have borrowed US dollars from non-banks, and have channelled these funds to other (unaffiliated) banks in the interbank market. By mid-2007, their total net claims on other banks (excluding inter-office claims) reached $443 billion, up from virtually nil in 1999.”
“At the same time, European banks have borrowed from other banks to
fund US dollar investments in non-banks. Their net liabilities to all banks, which include both uncollateralised loans and repo financing, grew to more than $800 billion by end-2007, much of this vis-à-vis other banks and official monetary authorities.”
These diverging positions of US and European banks suggest that the
latter face relatively large US dollar funding requirements.
“This may help in understanding the liquidity squeeze in this market since mid-2007, ” the paper finds. “Indeed, market commentary has suggested that European banks in particular had difficulty obtaining US dollar funding as the tensions in the interbank market unfolded in the second half of 2007. Interbank borrowing tends to be short-term, whereas banks’ investment in non-banks is of varying maturities. While the associated term risk may have been hedged, the build-up of European banks’ US dollar liabilities to other banks used to fund their US dollar non-bank assets may have required a frequency of rollovers in the interbank market that became difficult to maintain as market volatility increased”
As FT Alphaville notes, this helps explain the erratic behavior of Libor that has the Wall Street Journal and others up in arms.
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June 13th, 2008 at 2:26 pm
[...] Transparency is the word of the week. The lack of it continues to plague Lehman Bros (NYSE: LEH) as worries persist that the investment bank may not have marked down the value of its assets enough. Granted there is an argument that competitive considerations prevent full transparency, but it is becoming clearer that the market is no longer giving Lehman the benefit of the doubt. It will be interesting to see how wide CEO Dick Fuld opens the kimono on Monday when Lehman has another (last?) chance to restore confidence when it details first quarter numbers. Barring more bad numbers, the consensus is that Lehman will survive, but may not be able to stay independent. The challenge lies in finding a buyer or partner in the current climate. Moody’s warns that some US banks may still be undercapitalized while the BIS says European banks have greater funding needs than US banks. [...]