The euro is falling sharply against most counterparts during the European trading session. The single currency fell over 1 percent on the day versus the Swiss franc on mounting concerns of debt contagion in the euro zone as European banks are under stress due to high funding costs.
News yesterday that one unnamed bank in the euro zone has been forced to borrow USD 500-million from the European Central Bank to maintain the flow of funds to its business sent shock waves through the financial markets. It was the first time a euro-zone bank tapped the ECB for such funding since February. Though the loan involved a relatively small amount, it was the largest sum any bank had sought from the ECB in two years under a program that ensures European banks have sufficient access to U.S. dollars for liquidity. Lack of access to U.S. dollar financing was a key element of the 2008 crisis for European banks.
With three-month dollar funding costs at the highest since April, troubling signs emerge of a funding crunch, putting more stress on a banking system that is already battered by the biggest market sell-off in more than two years.
Banks rely on money markets for cash to fund their trades and loans. Fears about the fragile European bank system could reduce funding to banks. In the extreme cases such as the days immediately after the collapse of Lehman Brothers in September 2008, investors could stop funding banks completely, resulting in lack of liquidity and wreaking havoc on the global financial system. Investors have not completely cut off funding to European banks for now, but most of them are reluctant to lend beyond a week.