Apropos our article earlier today on Fed research on foreign bank liquidity during the credit crisis, here is an interesting story from Bloomberg on the Fed seeking more liquidity details from foreign banks. The Fed smells the smoke and wants to know if there is a fire under there. Soc Gen’s stake in Newedge, the prime broker is supposedly for sale.
Some foreign banks, most notably French institutions, reported saw their US$ liquidity sources squeezed in recent weeks. There have been stories about US$ swap lines being cut and money market funds pulling credit lines. But the fundamental question is: how will the large foreign banks change their US business models in response, and in particular their US$ repo and other cash intensive activities?
Unsecured funding is the first place a shock hits and it is good policy to minimize it. Long ago many Banks moved from simply (internally) lending unsecured cash to the businesses to obliging them to self-fund. Much of that funding is done in bilateral and tri-party repo markets. But if money market funds, for example, put the screws on foreign bank tri-party repo funding, we’ll be getting that déjà vu feeling all over again. Will the foreign banks start hacking away at their US$ trading operations to reduce their US$ funding dependency? That can’t be good.
Oct. 3 (Bloomberg) — The Federal Reserve Bank of New York may ask foreign lenders for more detailed daily reports on liquidity as the U.S. steps up monitoring of risks from Europe’s sovereign debt crisis, according to two people with knowledge of the matter.
Regulators held informal talks with some of the largest European lenders about producing a “fourth-generation daily liquidity” or 4G report, according to the people, who asked for anonymity because communications with central bankers are confidential. The reports may cover potential liabilities such as foreign-exchange swaps and credit-default swaps, said one person. The U.S. has already increased the number of examiners embedded in these banks, the person said.
Concern is growing that European lenders may falter as Greece teeters on the brink of insolvency. U.S. Treasury Secretary Timothy F. Geithner has warned that failure to bolster European backstops would threaten “cascading default, bank runs and catastrophic risk” for the global economy. European finance ministers were scheduled to meet today on how to shield banks from the fallout of a Greek default.
“The Fed is trying to understand what the pressure points are in terms of liquidity and potential risks that are imposed by foreign banks to domestic institutions in our financial system,” said Kevin Petrasic, an attorney at the Washington- based law firm of Paul, Hastings, Janofsky & Walker LLC. “There is a little bit more sense of urgency as a result of what’s going on in Europe.”
Liquidity Risk
U.S.-based money funds, which buy short-term commercial paper, have been shunning securities issued by some banks based on the continent, and European Central Bank Governing Council member Yves Mersch said Sept. 28 that liquidity shortages pose the main risks to the region’s banking system.
Jack Gutt, a spokesman for the Federal Reserve Bank of New York, declined to comment. The largest European bank holding companies by assets in the U.S. include units of Deutsche Bank AG, HSBC Holdings Plc. and Banco Bilbao Vizcaya Argentaria S.A., according to Federal Reserve data. Duncan King, a spokesman for Frankfurt-based Deutsche Bank, Thaddeus Herrick, a spokesman for Spain-based BBVA and London-based HSBC’s Rob Sherman said they couldn’t comment.
U.S. banks are starting to provide a 4G report and they are being phased in this month, said Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics Inc. Some Europeans are asking U.S. counterparts for information on how to prepare the report even though there has been no formal request from the Fed so far, one of the people said.
Avoiding a Squeeze
“The report requires rapid and in some cases daily data on a banks’ assets, liabilities and potential claims to measure the degree to which the bank could be caught in the classic borrow- short, lend-long squeeze,” Petrou said. “The 4G is one of the tools to reveal liquidity risk.”
The forms aren’t public, according to Petrou, and the New York Fed declined to provide a copy.
Euro-zone banks and other institutions were more than $350 billion in debt to the Fed’s emergency-lending facilities at one point during the 2008-2009 financial crisis, according to data compiled by Bloomberg News. The analysis was based on Fed documents released earlier this year after court orders upheld Freedom of Information Act requests by Bloomberg LP, the parent company of Bloomberg News, and News Corp.’s Fox News Network LLC. Fed lending to these entities totaled more than $100 billion on an average day.
Swap Contracts
Regulators lack access to data on foreign institutions operating in the U.S. that would allow them to “make informed judgments about the adequacy of such firms’ capital and liquidity buffers,” William C. Dudley, president of the New York Fed, said in a Sept. 23 Washington speech.
U.S. prime money-market funds cut their exposure to euro- zone bank deposits and commercial paper, or short-term IOUs, to $214 billion in August from $391 billion at the end of last year, according to JPMorgan Chase & Co. data. The funds are rationing their credit to European banks because of concerns that financial institutions will take large losses if a euro- zone nation defaults.
Credit-default swaps allow bondholders to buy protection against losses if an issuer doesn’t pay its debts. The contracts can entitle the holder to face value if the borrower defaults. Lawmakers and regulators have blamed misuse of swaps and lack of disclosure for helping to trigger the 2008 financial crisis.
A currency swap is a contract in which one party borrows one currency from another, and simultaneously lends another to the second party. Foreign-exchange swaps are used to raise foreign currencies for financial institutions and their customers, such as exporters and importers as well as investors.
Currencies and their related derivatives are among the most actively traded markets in the world, with average daily turnover reaching $4 trillion as of September 2010, according to Bank for International Settlements estimates.
–With assistance from Craig Torres in Washington, Caroline Salas Gage, Phil Kuntz, Bradley Keoun and Liz McCormick in New York, Keith Jenkins in London and Stephanie Bodoni in Luxembourg. Editors: Rick Green, Gregory Mott