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Signs of Stress Grow at European Banks
By Peter Coy
Europe’s debt mess has been festering for so long it sometimes feels more like a chronic condition than a life-or-death crisis. But as negotiations to prevent a Greek default drag on, investors and lenders increasingly are concerned that a banking crisis could break out, dragging down the Continental economy before Greece even has a chance to default. On Sept. 21 the International Monetary Fund estimated that Europe’s banks face more than $400 billion in losses and said that weak banks need to raise capital quickly.
The core of the problem? Some European banks are in peril of losing what they need most: cheap funding. Banks profit by borrowing money for short periods—rolling over some of their debt as often as nightly—to fund long-term loans at higher rates. As concern about their exposure to a sovereign default grows, European banks are paying more to borrow. Doubt about banks can quickly become self-fulfilling if worried depositors and lenders yank out their money. Remember: Lehman Brothers went from O.K. to dead in less than a week in 2008, when hedge funds and other banks concluded that the company couldn’t pay its bills.
Indicators of stress on European banks have risen sharply since midsummer. The eight largest U.S. money-market funds halved their lending to German, French, and U.K. banks over the past 12 months and stopped financing Italian and Spanish banks. Some Italian banks are so desperate for funds that they’re selling bonds to retail customers for five times the interest they offer on savings accounts.
Also, one arcane but critical sign of distress is the cost of a “basis swap”—a measure of how much European banks pay when they raise dollars by trading euro-denominated loans for dollar loans. The price of basis swaps has risen from 28 basis points (0.28 percentage points) of the deal value in mid-July to 98 basis points on Sept. 20. When the spread exceeds 150 basis points, “we are in large European bank failure zone,” says Conor Howell, head of exchange-traded funds trading at Christopher Street Capital in London.
The bottom line: Indicators of investor nervousness about the health of European banks are near or above their highest levels since 2008.
(www.businessweek.com/magazine/signs-of-stress-grow-at-europeanbanks-09222011.html. Adapted)
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