An employee enters the headquarters of French bank Societe GeneraleJOHN SCHULTS
Europe's banks are under siege.
Pressure on the Continent's leading financial institutions is mounting as troubling signs emerge of a funding crunch, putting more stress on a banking system that is already battered by the biggest market sell-off in more than two years.
Revelations this week that one unnamed bank in the euro zone has been forced to borrow $500-million (U.S.) from the European Central Bank to maintain the flow of funds to its business sent waves through the markets.
Though the loan involved a relatively small amount, it was the largest sum any bank had sought from the ECB in two years under a program that ensures European banks have sufficient access to U.S. dollars for liquidity. Lack of access to U.S. dollar financing was a key element of the 2008 crisis for European banks.
The move comes as regulators in other countries are trying to prepare for the possible fallout from Europe's sovereign debt crisis.
The U.S. Federal Reserve is meeting with the subsidiaries of European banks this week, seeking assurances that problems at their parent banks won't spread across the Atlantic. And in Sweden, regulators have told banks to begin preparing for a freeze in interbank lending markets, should the debt crisis in Europe worsen.
Those events combined to send bank stocks plummeting Thursday, but nowhere was the damage as deep as in Europe, where the sector saw its largest-single day drop since March 2009. The Bloomberg Europe Banks and Financial Services Index dropped 6.69 per cent. France's second-largest lender, Société Générale SA, dropped 12 per cent Thursday; it has shed half of its value since July.
The selloff raised the likelihood that temporary bans on short-selling put in place by several European countries last week to halt the slide in financial stocks may be extended into the fall.
"One of the undercurrents of concern was that some European banks were finding it difficult to obtain dollar lending," – that is, to borrow money in U.S. dollars, Otis Casey, an analyst with Markit Financial Information Services, said in a research note. "That was confirmed in a small but significant way," with the $500-million ECB loan sought by the unknown European bank, he said.
When banks must borrow at higher rates to fund their operations, it is a symptom of concern about larger problems in the financial system. The unnamed bank is paying a premium of one percentage point above the usual interbank lending rates, which is evidence the bank can not arrange lending through normal channels.
Further signs of stress are bubbling up in the interbank lending market in Europe. The premium banks charge each other when lending for three months has risen to its highest point since 2009, when markets were still smarting from the financial crisis.
Meanwhile, the cost of insuring the senior bonds of European banks is higher now higher than it was in 2008 when Lehman Brothers Holdings Inc. collapsed. The index of credit-default swaps in Europe is up 40 per cent since July, suggesting European bank bonds are far riskier proposition now than they were even a month ago.
Shares in Royal Bank of Scotland, which has fallen 43 per cent since July, dropped 11 per cent Thursday. Britain's Barclays PLCalso dropped 11 per cent, while Dexia SA, Belgium's largest bank, shed 14 per cent. In the U.S., Bank of America and Citigroup, the largest and third-biggest U.S. banks, each fell more than 6 per cent.
Canadian banks were also hit, though to a lesser degree, falling 2.6 per cent as a group. Canadian lenders began stockpiling cash at the end of July, with several of the country's largest banks shoring up $6-billion through the bond market in just over a week, including TD, Royal Bank of Canada, and Bank of Montreal. That is three times the amount Canada's banks would typically raise in a month in the bond markets.
Ongoing volatility in European bank stocks this week has fuelled criticism of the temporary bans placed on short selling in France Italy, Belgium and Spain. Regulators enacted the bans on short-selling, where investors bet that share prices will go down, fearing that negative sentiment and fear-mongering were compounding the problems in the markets.
However, Andrew Lo, a professor of mathematics at the Massachusetts Institute of Technology who studies short selling, said the bans rarely serve to prevent share sell-offs, and instead may do more harm than intended by reducing visibility in the market and making it harder to gauge negative sentiment.
"The politicians want the problem to go away, and they think that simply by eliminating short sales we've dealt with the problem," he said. "All we've done is to put blinders on our eyes, so now we don't know how bad the problem is."
Mr. Lo argues the ban will lead to pent up volatility, particularly since large institutional investors use short positions to hedge risk in their portfolios. When the temporary bans are lifted, it will lead to a "day of reckoning" in European markets, he said. "All that pent up fluctuation is going to get realized in a single day," Mr. Lo said. "What we've done is to inject artificial stability which will then generate artificial crashes as this day of reckoning ultimately ends up becoming realized."
Grant Robertson