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.