European banks have secretly increased their dependence on dollar funding by about $500bn in the last four years to some $800bn by mid-way through last year before the credit crisis turmoil struck. Much of the funding was apparently borrowed from US banks.
However, American banks, by contrast, have been raising most of their US dollar funding from money market funds, which they have then lent on to other banks, such as those in Europe, new research by officials at the Bank for International Settlements has shown.
This dramatic difference in the funding patterns may help to explain why Libor – the benchmark rate for interbank money markets – has continued to stay so high in recent weeks, in spite of the emergency measures introduced by the Federal Reserve, central bank officials believe.
In particular, in recent months it appears many US banks have slashed their dollar lending to other banks because they have been hoarding funds. This has created tensions in money markets as European banks, unlike their US counterparts, do not have direct access to the liquidity programmes offered by the US Federal Reserve.
Only three of the 16 banks that submit quotes to the British Bankers Association to calculate the Libor rate are domiciled in the US and have access to the Fed liquidity programmes. Central bank officials say this European bias may have exacerbated the upward pressure on dollar Libor.
“These diverging positions of US and European banks suggest that the latter face relatively large US dollar funding requirements,” the BIS notes in its latest quarterly report, released on Monday. “This may help in understanding the liquidity squeeze in this market since mid-2007.”
The BIS research is likely to be closely scrutinised by investors and bankers since it provides one of the first pieces of detailed analysis of bank borrowing patterns in the US and Europe.
Many officials have suspected that a distinction had opened up between the way US and European banks were behaving in relation to their use of dollar funding. However, since most of this activity tends to be highly secretive, it has been difficult for investors or bank analysts to analyse this divergence.