Money markets repo market slowdown underscores banks ecb dependence

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* Repo volumes shrink as euro zone banks prefer ECB cash* ECB dependency seen remaining high over longer term* Flood of ECB liquidity caps worsening of banking stressBy William JamesLONDON, Jan 23 Shrinking volumes for secured lending in the interbank market are symptomatic of the fractured trust between euro zone banks, and underscore the view that heavy reliance on the ECB will persist in the long term, analysts say. The volume of trade in the repo market, where banks commonly use government bonds as collateral to raise funding, has fallen in recent months according to trading platform data. Interdealer broker ICAP said repo volumes through its Brokertec platform were down by around 30 percent since the middle of the fourth quarter of 2011. Average Italian repo volumes over electronic trading system MTS have also fallen in January compared to December, according to information published on MTS's website. Analysts said this reflected banks' preference to use their collateral to draw long-term money from the European Central Bank rather than sourcing cash from the market.

"The recent reduction in volume seen across euro repo markets largely reflects the migration of collateral from the open market to the vaults of the ECB, via last December's three-year (refinancing operation)," said ICAP analyst Chris Clark. The decline in repo volumes affected both ends of the credit spectrum differently, Clark said, with investors preferring to hold onto low-risk German Bunds, whereas lower-rated collateral was safer to lend out to the ECB than to the market. Trust in the region's banking system has been badly hit by the sovereign debt crisis, sapping banks' appetite to lend and prompting the ECB to flood the market with access to cheap cash to prevent a serious funding squeeze. Banks borrowed 489 billion euros in three-year loans at the longest maturity cash injection the central bank has ever held, and demand was expected to be high for a second such tender at the end of February.

Banks have the option to repay the three-year loans after 12 months, but with no end in sight to the euro zone sovereign crisis, analysts expected reliance on the central bank to remain high over the long-term."It takes a long time to restore this confidence," said BNP Paribas strategist Patrick Jacq. Bank of France data showed French financial institutions increased their long-term borrowing from the ECB by 43.6 billion euros in the last month, taking a total of 107 billion euros as of Jan. 17.

DYSFUNCTION CAPPED Although the high degree of ECB dependence pointed to a dysfunctional interbank system, analysts said that while the sovereign crisis continued, the central bank measures were key to keeping stress limited and easing creditworthiness concerns."It helps to improve the perceived credit in the European banking system ... the consensus is that this is helpful to the whole banking system," said Commerzbank strategist Benjamin Schroeder. By providing long-term funding, banks are able to pay down the substantial volume of debt falling due this year. Supporting this view, a Reuters poll of money market traders showed a majority believed these steps had improved access to funding available on the previously moribund unsecured interbank market. The Libor rate for unsecured three-month euro borrowing fell for the 23rd consecutive session, down 0.01357 percent at 1.11214 percent. Nevertheless, anecdotal evidence suggested volumes were still very low and many institutions remain frozen out of the market.