Bank-Driven Squeeze in Funding Markets Is Hitting Every Corner

(Bloomberg) -- All corners of the funding market are now seeing increased year-end pressure but there’s no need to search for a culprit -- the fingerprints of global banks are all over the squeeze.

The consequences of lenders dealing with a creep higher in regulatory scores -- which determines the capital buffers they are required to hold -- has rippled through currency borrowing markets, Federal Reserve swap lines and even European repurchase markets.

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 12% since the end of September.

The rally in equities -- which has increased the value of banks’ stock holdings -- has likely put further upward pressure on regulatory scores and caused the lenders to seek ways to counteract the rise.

Here’s a look at some of the consequences:

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

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