Monday, March 17, 2008

Bank-To-Bank Lending Freezes; Bankers Ask 'Who's Next?'

By Mike Dolan and Kirsten Donovan

LONDON (Reuters) - Financial trading and interbank lending
almost ground to a halt on Monday as banks grew fearful of
dealing with each other following Friday's near collapse of
U.S. investment firm Bear Stearns (BSC.N: Quote, Profile, Research), prompting talk of
another round of coordinated central bank aid.

As banking stock prices and the U.S. dollar plummeted,
banks' access to unsecured borrowing from other banks fell to a
relative trickle and dealers said the over-the-counter market
had become highly discriminatory, depending on the bank name.

The seizure in money markets was reflected in a dramatic 80
basis point surge in overnight dollar London interbank offered
rates (Libor), the biggest daily increase since the attacks of
September 11, 2001.

"Banks and institutions are just scrambling for cash, any
cash they can get their hands on," said a money market trader
at a European bank.

"And it's seen as a U.S. market problem for the moment, or
a dollar problem anyway," he said, noting the relatively modest
increase in overnight euro and sterling Libor.

Published dealing rates were unreliable and analysts said
any bank that had not already secured funding further than a
week or so would struggle to raise cash at all.

"Bear's near-collapse and takeover accelerates the
liquidity crunch and the money market crisis," Dresdner
Kleinwort analyst Willem Sels told clients in a note.

"Banks' risk aversion and sensitivity to counterparty risk
should rise even further, leading to more pressure on hedge
funds. Money markets are having a brutal wake-up call."


Bankers said they were struggling to assess developments
since the New York Federal Reserve said on Friday it was
propping up the stricken firm via Wall St bank JP Morgan
(JPM.N: Quote, Profile, Research), and intense concerns about the stability and solvency
of financial counterparties had dealing volumes in lending
markets seize up.

In an effort to minimise the fallout and in conjunction
with the fire sale of Bear Stearns to JP Morgan, the Fed on
Sunday cut its discount lending rate by a quarter percentage
point to 3.25 percent and announced another series of liquidity

But with concerns about whether other firms may meet a
similar fate to Bear Stearns, nerves on every trade were

"It's quite illiquid this morning. If you want unsecured
cash you're really going to have to pay up for it. It's really
quite an intense situation," said Calyon analyst David Keeble.

Banks led the losers as stock markets lost more than 3
percent. UBS (UBSN.VX: Quote, Profile, Research), Royal Bank of Scotland (RBS.L: Quote, Profile, Research) and
Barclays (BARC.L: Quote, Profile, Research) all fell more than 8 percent. HBOS (HBOS.L: Quote, Profile, Research)
and Alliance & Leicester (ALLL.L: Quote, Profile, Research) slid more than 11 percent.

Shares in Lehman Brothers (LEH.N: Quote, Profile, Research) dropped 34 percent before
the opening bell on Wall St.

"There's turmoil in all markets after Bear Stearns," said
BNP Paribas strategist Edmund Shing. "Everyone's asking: Who's
next? Is there a Bear Stearns in Europe? Could investment banks
start to fail?"

The problem was said to be particularly acute in sterling
markets, with the gap between indicative three-month interbank
borrowing rates and the Bank of England loans more than 70
basis points -- the highest for the year.

Some analysts said major players on the interbank market
had been doing as little as 700 million pounds a day of
business over the past week, a fraction of the several billions
that would have been executed a year ago, and far less on

"Counterparty risk is back in play, every trade is being
scrutinised ahead of time," one interest rate trader said. "

The stress in the market forced the UK central bank to make
an emergency offer of five billion pounds of three-day funds.

"This action is being taken in response to conditions in
the short-term money markets this morning," the Bank said in a
statement. "Along with other central banks, the Bank of England
is closely monitoring market conditions."


Three-month euro interbank rates were also some 65 basis
points above ECB rates, compared with around 40 basis points at
the start of the month. The spread reached a peak of around 90
at the end of last year.

Dollar spreads were also wider than on Friday but heavy
discounting of further Fed rate cuts have meant the spread has
actually narrowed this month to around 65 versus 80 basis
points at the start of March.

The European Central Bank declined to comment, even though
speculation of coordinated central bank statements, liquidity
injections and even synchronised rate cuts circulated around

A German finance ministry spokesman said no extraordinary
meetings of the Group of Seven economic powers was planned.
"We're watching developments very closely in the United

But International Monetary Fund chief Dominique
Strauss-Kahn said the global financial markets crisis was
worsening and risk of contagion was increasing.

With the dollar sliding to record lows, traders said
currency options markets were seizing up too, another
reflection of the state of panic and fear that appears to be
dominating all financial markets.

Implied volatilities on FX options, a measure of expected
volatility in the underlying asset price and investors' demand
to protect themselves against these moves, soared on Monday.

As the dollar sank to 13-year lows against the yen further
below 100 yen, one-week dollar/yen implied "vols" <JPYSWO=>
jumped to 25 percent, a level not seen since 1999.

"This is a market where you should be on your guard.
Shorting options is quite a difficult position to manage," said
the senior FX trader in Tokyo.

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