European Banks Find Depositor-Of-Last-Resort. For Now!
We have highlighted the crisis-level situation that short-term liquidity markets find themselves in across Europe at length with banks using every gimmick and instrument they can in order to avoid transparency and insolvency. Whether it's cross-currency basis swaps, FRA/OIS spreads, or simply ECB emergency funds and Fed swap lines, its clear they are running out of 'lenders'. With the interbank repo market as good as closed to most of the Italian banking system, NY Times DealBook has discovered an unusual source of funding via the London Stock Exchange's Italian clearinghouse Cassa Di Compensazione E Garanzia SpA (CC&G). Acting as the middle-man for short-term (3-day) collateralized loans, CC&G basically acts as a depositor for the Italian banks (which make up more than half the 15 European financials that are using this source). While arguably they are not explicitly lending money, merely term-depositing cash, the distinction provides cover in the case of a credit event but there is still (obviously) significant risk of loss given the forms of collateral and potential rapidity of cash-calls.
The London Stock Exchange is becoming the lender of last resort for many banks in Italy as concerns over the country’s debt levels squeeze liquidity out of the Italian financial market.
With cash increasingly hard to come by, Italy’s banks are turning to CC&G, the exchange’s Italian clearinghouse, for short-term lending. That includes some of the country’s largest financial institutions, including Unicredit and Mediobanca, according to a person close to the situation.
While just two banks received short-term capital from CC&G in 2009, that number has now risen to 15 — half of them Italian and the rest European financial institutions that trade in the country.
Under terms of the deals, the clearinghouse, which acts as a middleman to guarantee trades between financial parties, is offering money to both Italian and European banks with a presence in Italy for up to three days.
The money, which comes from collateral that traders must put up to complete financial transactions, is deposited with the banks to cover shortfalls in liquidity. CC&G earns a profit by charging banks interest on the money that they borrow.
Previously, banks had used the so-called repo market, where banks lend capital to each other on a short-term basis, to meet their financing requirements. But fears about Italy’s ability to repay its debts has pushed up borrowing costs and reduced the ability of banks to access that market.
A spokesman for the exchange said the company was in close discussions with the Italian central bank about any potential problems in the country’s financial sector, and used stringent risk management to decide whether to give banks access to capital.
CC&G also doesn’t technically lend money to banks, but instead deposits the cash with them on a short-term basis. Under Italian law, this distinction makes CC&G a depositor with the banks, and places it ahead of other creditors looking to get their money back if any financial institution should fail.
The legal distinction may still leave CC&G exposed if a lender defaults. And analysts question the sustainability of lending to struggling banks. That’s particularly true as the collateral offered to institutions as short-term financing is often provided by the same bank’s separate trading operations.
Paul Rowady, senior analyst at financial consultancy TABB Group in Chicago, said the global squeeze on liquidity was forcing institutions to look elsewhere, including to clearinghouses, to meet their short-term financing commitments.
He added that central clearing parties might feel secure in lending to banks because it was on a short-term basis and they were eager for extra revenue.
“Financial entities are making money in new and different ways,” he said. “Just because times are bad doesn’t mean they’re not looking for profits.”
And Italy’s turmoil has been good business for the London Stock Exchange. According to the exchange, CC&G reported a 209 percent jump in income to £54.3 million, or $83.6 million, during the first half of the year, compared with the same period in 2010.
The Italian business now represents 14 percent of the exchange’s overall income, compared with just 5 percent in the first half of 2010.
In our ever-so-humble opinion, this should be added near the top of the list of crisis canaries-in-the-coal-mine as the cracks of desperation appear more and more across the largest and most-levered financial firms in the world.