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Monday, March 11, 2013

Some more signs of financial market fragmentation in the eurozone?

The European Repo Council of the International Capital Market Association (ICMA) released its bi-annual assessment of the European repo markets today. Admittedly, not the most exciting of intros but the survey does contain some interesting points regarding financial markets in the eurozone. As a reminder, repo markets are the main source of short term funding for banks (or at least they should be if markets are functioning normally).

The report highlights that repo funding fell by 11.9% during 2012 (based on a standard sample size). Interestingly, the fall slowed significantly in the second half of the year – there was only a 0.9% drop in the market from June to December. This is likely to have been down to the creation of the ECB bond buying programme, OMT.

There are a few other interesting points and conclusions which can be drawn from the report:

  • As of the start of this year, European banks remain heavily reliant on ECB funding. The LTRO repayment has shown this has decreased somewhat. However, as we previously noted, if the repo market does not pick up the slack then we could see a de-facto tightening of monetary policy (the opposite of what the ECB is trying to achieve).
  •  There is some evidence of an increase in cross border repos up from 48.1% to 50.5%. However, importantly, cross border repos between eurozone only countries remained steady – suggesting significant market fragmentation remains in the eurozone.
  • The share of transactions which we were for a maturity of a year or more dropped from 13.3% in June to 5.9% in December, suggesting banks filled much of their long term financing needs at the ECB LTRO. This will be an interesting indicator to watch in the next survey to judge the impact of LTRO repayments.
  • The ICMA also go to lengths to highlight the threat of the financial transaction tax (FTT) to the repo markets.
  • Government bonds, especially from core eurozone countries, remained a key source of collateral for repo transactions. In fact, the use of German government bonds as collateral increased sharply. Usually, this would be seen as a sign of risk aversion and a flight to safety (i.e. negative for the prospect of recovery), however, ICMA suggests this is actually a positive sign since previously these bonds were being hoarded to improve balance sheet safety. Still, the over-reliance on core government bond highlights the shortage of safe assets in the eurozone and should be taken into account when considering why borrowing costs have remain low despite increased tensions in the eurozone once again.
Overall the survey seems to confirm fears that fragmentation remains in the eurozone financial markets, as does over-reliance on the ECB - at least up to the end of 2012. The real question is whether this has been reversed at all at the start of this year. Unfortunately, we’ll have to wait until the September survey for a conclusive answer on that point.


Rik said...

Bit old news.
Because of the Italian election, Spanisgh corruptionscandal and a few other things markets re Spain and Italy have become nervous again.
If this remains that way it will be the real test. But more likley the trend will be reversed.

Looks to be more armtwisted banks and muppets running for yields than anybody with a brain (those still only are in for the short term for the tradegains and not as a real investor). The latter will likley run for the exit when things get under pressure again.

Jesper said...

Other source for cash, Target2 balances:

System looks broken still, might be improving or might reverse.

Rik said...

latest Target2 figures confirm this. However as with all related subjects these are all figures from the good times, now times look to get darker we have to see if it is structural or not. Imho it simply doesnot look structural.

jon livesey said...

Obviously this is a pretty long-term trend. I think we started to see this getting serious around the time that LTRO began.

I commented at the time that it meant that euro-zone funding was becoming less of a network and more a "hub and spokes" with the ECB the hub and the national central banks the spokes.

And it's not too surprising, because in a real crisis, a hub and spokes system is going to be a lot easier to manage than a network.

Jesper said...


you might be right, however, I don't think that enough data is available.

It does look like savings from Germany have found its way to Spain through other means than through the NCBs and target2. Repos MIGHT be the full explanation but I doubt that.

Maybe 'hot-money' is flowing to Spain? Maybe some investors are willing to risk a haircut in Euro rather than risk a loss through devaluation (UK pound, USD etc)

High-level data will hide a lot of detail and therefore I am reluctant to believe that three data-points is enough evidence to substantiate a claim about a trend.

This is what one analyst has to say about Spain:
The real picture is probably somewhere in between the official stress tests and his numbers.

Officials at the EBA should be technocrats and their analysis should be accurate, however, I'd not be surprised if pressure would be put upon the EBA and their numbers turned out to be fantasy -> EBA end up being less credible than people might wish