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Draghi’s Cash Triggers Unprecedented Drop in Bank Lending Stress

ECB President Mario Draghi
ECB President Mario Draghi’s pledge to stand behind the currency of the 17- nation euro area in July eased stresses in money markets, where banks fund their day-to-day business. Photographer: Ralph Orlowski/Bloomberg

European Central Bank President Mario Draghi’s $1.3 trillion of cheap loans and pledge to do whatever it takes to stand behind the euro helped push indicators of stress in the continent’s money markets down by an unprecedented degree this year.

The difference between the euro interbank offered rate and overnight index swaps, a measure of European banks’ reluctance to make unsecured loans to one another known as the Euribor-OIS spread, contracted a record 0.85 percentage point this year to 0.12 percent, according to data compiled by Bloomberg.

The Frankfurt-based ECB has lent financial institutions more than 1 trillion euros ($1.3 trillion) under its longer-term refinancing operations since December and is committed to providing cheap, unlimited cash for lenders to boost the economy. Draghi’s pledge to stand behind the currency of the 17-nation euro area in July eased stresses in money markets, where banks fund their day-to-day business.

“The key catalyst behind this year’s contraction has been Mario Draghi and the ECB,” said Chris Clark, a London-based interest-rate strategist at ICAP Plc, the world’s largest interdealer broker. “First through the three-year LTROs and later with Draghi’s commitment to do whatever it takes and subsequent announcement of the outright monetary transactions.”


The Euribor-OIS spread narrowed from as much as 2.07 percent four years ago, and is now little more than twice its typical level before the financial crisis broke. The spread widened in 2011 and 2010 and this year’s contraction is poised to beat the 84.5 basis-point drop in 2009. A basis point is 0.01 percentage point.

Low interest rates also helped spur a drop in money-market stress indicators. The ECB held its main refinancing rate at an all-time low of 0.75 percent on Dec. 6, a month after Draghi fueled speculation he would put reductions back on the agenda, saying the euro debt crisis was starting to hurt Germany and that inflation risks were “very low.”

While low interest rates were beneficial for banks’ borrowing costs, they meant trouble for money-market funds investing in Europe.

Because they’re designed to be haven investments that return members’ cash intact rather than make huge profits, the ECB’s zero-percent deposit rate, as well as the negative yields on some of the safest European government bonds, narrowed the field of investments for these funds.

Fidelity’s Response

Fidelity Worldwide Investment, an affiliate of the second-largest mutual-fund company in the U.S., extended the average maturity of its holdings to boost yields earlier this year, while Ignis Asset Management Ltd. responded to the record-low interest rates by broadening its range of investments.

Chicago-based Northern Trust Corp., the third-largest U.S. independent custody bank, waived fees and offered clients tailored investments. Bank of America Corp. and JPMorgan Chase & Co. either closed funds or turned away investors because of a lack of safe assets.

The cost of insuring against a default on European bank bonds has also declined by the most ever this year. The Markit iTraxx Financial Index of credit-default swaps tied to the senior debt of 25 banks and insurers fell 141 basis points since Dec. 30, 2011, to 138 basis points.

The gauge had risen every year since the start of the global financial crisis apart from 2009, when it narrowed by 43 basis points, according to prices compiled by Bloomberg. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

Euribor Falls

Three-month Euribor, a loan rate reported by banks, fell 117 basis points this year to 0.186 percent. The benchmark, derived from a daily survey of banks for the European Banking Federation, is set for the first annual decline since 2009, when it tumbled 219 basis points.

The EBF’s euro overnight index average, or Eonia, of unsecured lending deals fell 57 basis points to 0.06 percent, according to data compiled by Bloomberg. The Eonia swap, an estimate of overnight borrowing costs over the next three months, dropped 31.5 basis points to 6.5 basis points.

The cost for banks to borrow in dollars and swap the proceeds to euros fell this year by the most since at least 2009. The three-month cross-currency basis swap was 26 basis points below Euribor, compared with minus 114 basis points on Dec. 30, 2011, Bloomberg data show.

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