Thursday, December 13, 2007

ECB Warns of Off Balance Sheet Risk

From the FT this morning:

ECB warns of danger of a wider liquidity squeeze

By Gerrit Wiesmann and Ivar Simensen in Frankfurt

Published: December 13 2007 02:00 | Last updated: December 13 2007 02:00

The eurozone's 21 largest banks hold €244bn (£175bn, $359bn) in off-balance sheet assets that may have to be brought back on to their balance sheets and could trigger a credit squeeze in the wider economy, the European Central Bank warned yesterday.

Fears that banks could be forced to take these assets on to their books have fuelled the liquidity squeeze.

Liquidity in the inter-bank money markets has dried up as banks have shored up funds as a precaution to taking these assets on their books, the ECB said in its biannual report on financial stability in the eurozone.

The ECB said the top 21 banking groups in the eurozone faced additional funding requirements of €244bn if they had to take their total exposure to asset-backed commercial paper and leverage loans - asset classes that have been the hardest hit by the credit crunch - back on their books.

With an average exposure of €11.1bn or 6 per cent of loans, the ECB said all banks would remain adequately solvent even if all assets were downgraded from their current mostly high ratings of AAA and AA to below investment grade and transferred to balance sheets. But it warned that could raise the banks' own funding costs, forcing them to cut payouts to shareholders and seek new capital. It could also erode banks' ability to lend, which could foster "a credit crunch in the wider economy".

Lucas Papademos, vice-president of the ECB, said yesterday the added liquidity provisions were needed in order to "mitigate the spill-over effect from the money markets into other markets, particularly the credit market". Problems stemming from the US subprime mortgage market rippling into the global credit markets have left the eurozone more exposed to shocks in its own private and commercial loan markets, the ECB warned. It said banks and investors could face a "challenging" adjustment process that could leave the system "more vulnerable than before to the crystallisation of other risks".

It said risks to financial stability had "materially increased" since its previous assessment mid-year, which was all the more startling given that the report was concluded at the start of November, when market distortions appeared to be easing. Mr Papademos said the pressure on market conditions had "elevated" in the month since the report was concluded.

The central bank for the 13-member currency area said a "substantial increase" in household debt coupled with signs of declining house prices in some markets added to the credit risk facing banks "in the short to medium term".

The economic outlook of the eurozone remained "broadly favourable" and the balance sheets of households, businesses and big banks were soundly creditworthy, said the ECB.


Central banks step in over credit crisis

By FT Reporters

Published: December 12 2007 14:25 | Last updated: December 13 2007 00:46

European and North American central banks on Wednesday unleashed a co-ordinated attempt to end the credit squeeze in global financial markets, setting off a wild day of trading as investors tried to make sense of a barrage of measures to increase market liquidity.

The Federal Reserve, European Central Bank, Bank of England, Bank of Canada and the Swiss National Bank all announced steps to make cash more readily available to banks. The Bank of Japan and Reserve Bank of Australia voiced support.

The actions – described by the Bank of England as an attempt to “demonstrate that central banks are working together to try to forestall any prospective sharp tightening of credit conditions” – helped ease pressure in money markets, a vital area of concern for policymakers. One-month Libor – the rate at which banks borrow from each other – was expected to set at 4.99 per cent on Thursday, down from 5.10 per cent on Wednesday.

However, conditions in the money markets remained strained by normal standards. Stocks also gave back most of their gains after surging earlier in response to the announcements.

The Fed said it was forming a new credit auction facility – first revealed by the Financial Times – that will offer cash to banks in return for a wide range of collateral, including housing-related securities. The Fed said it would hold two auctions of $20bn each in one-month loans this month.

The ECB and the Swiss National Bank said they had entered into so-called swap arrangements with the Fed to auction $24bn in dollar funds to banks in Europe. The two initiatives effectively form a new onshore and a new offshore dollar liquidity facility, and the Fed is willing to consider increasing both if required.

However, this is not all net new money, as the Fed is likely to pare back the amount of liquidity it would have provided through open market operations.

The Bank of England and the Bank of Canada, meanwhile, announced sweeping changes to their collateral rules to allow banks to pledge a much wider range of securities in exchange for funds.

Lucas Papademos, vice-president of the ECB, said the actions were “aimed at easing pressures and containing pressures in the term money market”.

Analysts hailed the announcements as evidence of the world’s top central bankers working together, but some traders were angry at the Fed for failing to signal the decision after its Tuesday policy meeting.

A senior Fed official said: “This was a global effort...We could not have announced yesterday as Europe was closed.” He said the announcements had “nothing to do” with the negative reaction to the Tuesday rate cut.

The S&P 500 opened more than 2 per cent higher, but dipped into negative territory as oil prices surged and ended up 0.6 per cent. Yields on two-year Treasuries rose 21 basis points to 3.13 per cent. However, interest rates for shorter-dated Treasuries barely moved – a sign of continued risk aversion.

and the guardian:

Central banks get a grip of Libor...finally

By Jamie McGeever

Finally, the world's leading central banks may be gaining traction in their battle to free up liquidity in credit markets, restore confidence in the global banking system and prevent slowing economic growth from, in some cases, spilling over into recession.
But the surprise package of measures announced by major central banks on Wednesday may not be enough on its own to completely fully thaw the credit market freeze and further policy easing -- not to mention patience -- may be required.
For example, it will take time for banks to confidently lend to counterparties still thought to be saddled with debt-related losses, months of tight credit still has to work its way through the economy and prolonged financial market stress simply won't be waved away with a magic wand overnight.
Still, the measures which include the creation of a short-term lending facility from the Federal Reserve and a $24 billion currency swap facility between the Fed, European Central Bank and Swiss National Bank, should help ease year-end funding tensions. "This will certainly help alleviate the liquidity squeeze but the main problem is still persuading banks to make liquidity go around, not just sit on it," said Marco Annunziata, chief economist and global head of fixed income research at UniCredit Markets & Investment Banking.
"For this we also need more transparency on the write-offs and losses, which i think we will get in the next few months. So I do think this is a very important and positive step, but you will also need more clarity to see liquidity conditions normalize in asset markets," he said.
Banks around the world have racked up losses and debt-related writedowns stemming form the collapse of the U.S. subprime mortgage market of more than $60 billion in recent months.
Immediately after the package was unveiled, indicated money market rates for dollar, euro and sterling deposits across the one-three month spectrum fell, suggesting Thursday's daily London interbank offered rates (Libor) will be fixed lower.
Late Wednesday, indicated market rates were all below their respective Libor rates at the British Banking Association's daily fixing, which came before the central banks' announcement.
One-month sterling deposits were indicated at 6.35 percent, almost 40 basis points below the three-month Libor rate of 6.74625 percent.
And three-month euro deposit rates were trading at 4.85 percent, around 10 basis points below the 4.95250 percent Libor fix.
Tensions have been high in money markets since August as the credit crisis nearly shut key funding channels for banks, namely the asset-backed commercial paper market.
Laurent Fransolet at Barclays Capital said Libor rates could be fixed lower in the days ahead by as much as 20 basis points.
The biggest impact will likely be seen in sterling rates, where higher fixings have had "the strongest, most direct" effect, and the most limited in the euro zone.
But it will take time for the recent market carnage to heal.
"While this would still be way above pre-crisis levels, we suspect it will be difficult for the market to fully recover in the near term. After all, the ABCP market in the U.S. is about 30 percent smaller than at its peak and that of the euro area has almost halved, making the combined shrinkage more than $500 billion over the past five months," he wrote in a note.
If Libor rates do fall Thursday, it will be the first downward move in three-month euro Libor for over a month.
Before the measures were unveiled on Wednesday, three-month euro Libor rates rose to 4.95250 percent from 4.92688 percent, the biggest gain this month and the 21st straight increase.
One-month euro Libor rates rose to 4.94500 percent from 4.92250 percent, their highest since December 2000.
The premium of three-month Euribor rates over three-month euro overnight index average (EONIA) rates (a weighted average of all overnight unsecured interbank lending) widened to 90 basis points on Wednesday.
That's the widest in several years, wider than the initial peak after the credit crisis blew up in August, and around 40 basis points wider in the past month alone.
Like others, Lena Komileva, Group G7 economist at Tullett Prebon, also took a cautiously optimistic view.
"We expect that today's measure together with the drop-out of year-end effects from the market's pricing will help bring some temporary relief for funding markets and overt serious systemic risks at the turn of the year," she said.
"Nevertheless we expect that risk premia will be maintained above the levels seen in recent years into 2008 as the credit crunch enters a more mature stage." (Editing by Ron Askew)

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