With funding ever harder to come by, banks are resorting to the financial industrys equivalent of a pawn broker: parking assets on repo markets or at the central bank to get cash. We have no alternative to deposits and the ECB, says a senior executive at one European bank.
So far the liquidity of the European Central Bank has kept the system alive. Only one large European bank, Dexia, has collapsed because of a funding shortage. Yet what happens if banks run out of collateral to borrow against? Some already seem to scrape the barrel. The boss of UniCredit, an Italian bank, has reportedly asked the ECB to accept a broader range of collateral. And an increasing number of banks are said to conduct what is known as liquidity swaps: banks borrow an asset that the ECB accepts as collateral from an insurer or a hedge fund in return for an ineligible assetplus, of course, a hefty fee.
The risk of all this is two-fold. For one, banks could stop supplying credit. To some extent, this is already happening. Earlier this week Austrias central bank instructed the countrys banks to limit cross-border lending. And some European banks are not just selling foreign assets to meet capital requirements, but have withdrawn entirely from some markets, such as trade finance and aircraft leasing.
Secondly and more dangerously, as banks are pushed ever closer to their funding limits, one or more may failsparking a wider panic. Most bankers think that the ECB would not allow a large bank to fail. But the collapse of Dexia in October after it ran out of cash suggests that the ECB may not provide unlimited liquidity. The falling domino could also be a shadow bank that cannot borrow from the ECB.
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