Bank-Driven Squeeze in Funding Markets Emerges as Stocks Rise
Year-end pressures are rising in many corners of the funding markets as swelling equity valuations push up banks’ capital need.
(Bloomberg) -- Rising share prices are increasing year-end pressures in many corners of the funding markets as swelling equities valuations push up banks’ need for capital.
The consequences of lenders dealing with a creep higher in regulatory scores -- which requires banks to hold a larger capital buffer -- have rippled through currency borrowing markets, Federal Reserve swap lines and even European repurchase markets. The rally in equities has increased the value of banks’ stock holdings, which has likely put more upward pressure on regulatory scores -- triggering lenders to seek ways to counteract the rise.
Last week’s latest systemic risk reports showed most bank regulatory scores were edging higher in the third quarter, “even before we factor in the post quarter-end equity price moves,” according to a note by JPMorgan Chase & Co.’s Henry St John. The MSCI AC World Index is up about 12% since the end of September.
The pressures currently bubbling up come as many Wall Street firms predict that this year-end won’t be marked by an outsized funding shortfall, given reasons including a likely decline in Treasury bill supply and an increase in bank reserves. Some analysts have noted that statements in banks’ recent earnings calls suggest regulatory scores aren’t close to levels that would require additional capital.
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Here’s a look at some of the consequences in markets right now from banks feeling pinched by regulatory pressures ahead of year-end:
Currency Hedging
First up, banks appear to be scaling back on lending U.S. dollars in short-term currency markets. That has led to a spike in one-month dollar premiums, relative to their three-month counterparts.
Banks are also said to be looking to reduce the amount of stocks held on their balance sheets -- which would lower regulatory scores -- by lending out positions through equity total-return swaps. However, investors willing to participate in the transactions need to have U.S. dollars, which has led to a surge in the usage of the Fed’s swap lines to access them.
Dollar Swap Lines
Swap line activity is particularly high via the Swiss National Bank, which over the past eight days has seen $5.7 billion borrowed at three-month tenors.
The decision to go through Switzerland is purely economic. The SNB offers swap lines with no haircuts for many securities. That compares with the Bank of Japan which lends dollars equivalent to 98.6% of the value of 10-year government bond collateral or the European Central Bank which offers just 96% of the value of a comparable German bund.
Banks Find Dollars Are Cheaper in Switzerland: Liquidity Watch
General Collateral
But, if an investor doesn’t own the bonds required to pledge as collateral for dollars, they need to be borrowed and that’s hitting the repo market. The cost to borrow German and French bonds for one-month -- known as the general collateral rate -- has surged, hitting the most negative in two- and three- years respectively.
A negative rate means that the buyer of the bond repurchase agreement -- the investor lending the cash to access the securities -- is paying interest.
Meanwhile, three- and 12-month Euribor, the unsecured rates that banks can theoretically borrow from each other, fell to record lows of minus 0.534% and minus 0.499% respectively.
German Repo Squeeze a Risk as ECB Keeps Buying: Liquidity Watch
Three-month dollar Libor has traded in a narrow range over recent weeks and holds just above a record low of 0.2049% set on Nov. 20. The benchmark rate was fixed Monday at 0.2304%, up 0.5 basis point versus Friday.
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