Europe's Banks Hoard Cash

By CARRICK MOLLENKAMP , DAVID ENRICH And MARK GONGLOFF

Some European banks are holding more tightly to precious cash amid signs that a key avenue of money-raising is slowing, according to bankers operating in the European finance hubs of London and Brussels.

In the past month, the amount of short-term IOUs, or commercial paper, issued by some European banks in Spain, Portugal, and Italy has fallen. At the same time, banks fortified with cash are opting to hoard it by moving the funds to the European Central Bank rather than lend it out to other banks.

Both moves illustrate elements of financial contagion moving across Europe that so far has been contained from becoming worse because of credit available from the ECB.

A key area that is showing signs of weakness is the short-term IOU market, where banks sell commercial paper to investors such as money-market funds. In London, a market for euro-commercial paper for some 68 countries outside the U.S., big banks are showing declining outstanding debt. A separate commercial-paper market in the U.S. also is showing weakness.

According to one London trading desk and data-research firm Dealogic, Spanish and Portuguese banks have posted significant drops in outstanding euro commercial paper between this week and April 30.

The precise decrease for the amount outstanding is not available but the trading desk and Dealogic say the amount is at least $1 billion per bank.

Euro commercial paper issued out of Ireland also has shown a drop. Some Spanish and Portugese banks put offshore units in Ireland, which could account for the drop.

The decrease also could represent a move by banks to rely more on stable deposits from customers and less on volatile wholesale-funding markets.

European banks are also active participants in the U.S. commercial-paper market. Demand for their short-term debt was brisk until the latest flare-up of sovereign-debt worries, and they accounted for at least a third of all borrowing in the $1 trillion market at the beginning of May, according to some estimates.

As the crisis intensified, U.S. money-market funds and other investors in commercial paper lost some of their appetite for short-term European bank debt.

Though a breakout of European commercial paper outstanding isn't available, the total amount of foreign banks' commercial paper outstanding has shrunk by about $32 billion, or 15%, since the week of April 21, according to Federal Reserve data. The Fed is due to update its weekly commercial-paper data on Thursday.

European banks' reluctance to lend to each other, even on a short-term basis, is evident in the increasing amount of funds that they are stashing overnight at the European Central Bank. While the deposit levels are volatile, bankers and traders say they offer an approximate proxy for banks' appetites for lending to each other. The ECB is a virtually risk-free home for banks' overnight deposits, but the central bank offers a paltry interest rate of 0.25%. That's well below what banks could fetch by lending their funds to other banks overnight, bankers say.

In early May, when concerns about Greece's fiscal woes reached a fever pitch, the ECB's deposit facility totaled nearly €315 billion ($388.5 billion) in bank deposits, the highest since July 2009. After dropping off in subsequent weeks, the deposits have been on the rise again.

On Wednesday, the ECB said about €268 billion was parked in its deposit facility, up from €264 billion on Tuesday and €253 billion the day before. Banks, including Spanish banks, have been shifting their funds into the ECB, preferring to accept a lower interest rate in exchange for less risk, according to people familiar with the matter.

Backstops do exist and that is giving the market some comfort.

Banks struggling to borrow in the market at a reasonable rate can turn to the ECB for a loan. The ECB has more than €800 billion in loans outstanding to banks, a level that's approaching the peak hit last July, according to a report Wednesday by UBS AG banking analysts Alastair Ryan and John-Paul Crutchley.

"We believe the current stress in funding markets will take it back to record levels in coming weeks," the analysts wrote.

The availability of funds from the ECB means European banks are less likely to encounter the sorts of liquidity crises that killed or crippled major financial institutions like Lehman Brothers Holdings Inc. and Royal Bank of Scotland Group PLC in the heat of the financial crisis in 2008 and 2009.

But bankers and analysts say that lenders that rely on funding from the ECB could be perceived by the markets as weaker, making it even harder for them to drum up financing from private sources and thereby becoming even more dependent on the government as a source of liquidity.

http://online.wsj.com/article/SB1000142 ... theadlines