The Hunt for Dollars by Europe’s Banks

This is another sign of the stresses — due to uncertainty, fear, and lack of trust — that seem to be growing within the European banking system, and it’s also an important clue as to why European banks have been shifting cash to the US and building up their dollar reserve assets:

Dollar borrowing costs add to strain on European banks

European banks are facing increasing strains on their balance sheets because of the dramatic jump in the cost to borrow dollars, essential for some institutions as they need to repay loans in US currency.

The cost for European banks to swap euros into dollars has jumped fivefold since June, hitting the highest levels since December 2008, and raising the risk of insolvency in the region’s financial sector.

…The main reason for the spike in the cost of swapping euros for dollars is the overwhelming demand for the US currency due to its growing status as a haven in the face of rising worries of an imminent Greek default that could spark a deeper sovereign debt crisis.

European banks, which need to borrow dollars to repay loans, face an extra premium of 103 basis points to swap euros into dollars for three-month loans – a dramatic jump since June when they only had to pay an extra 20bp.

Don Smith, economist at Icap, said: “More and more banks want dollars because of worries about the debt crisis in Europe. This leads to a vicious circle where the cost to swap dollars for euros rises and creates even more strains and potentially deeper problems for the financial sector.”

Since dollars are growing more scarce and more expensive for European banks as they seek safety from possible fallout of the eurozone debt crisis, it makes all kinds of sense for them to try to increase their dollar reserves. Which may explain why it is foreign-owned banks that have acquired nearly all of the ~$600 billion in new reserves created by the Fed over the past 8 months.

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