Soaring repo rates show ongoing banking stress

By Kirsten Donovan - Analysis

LONDON (Reuters) - A desire by banks to lock in longer-term funding and keep collateral off their balance sheets has seen the premium paid for secured borrowing in repurchase makets soar to its highest in over 5 years.

With access to interbank markets severely restricted by the credit crunch and limited to only a handful of top-tier institutions, benchmark Libor rates have stabilised in recent weeks. And analysts now say the repurchase, or repo market -- which is being used by a much larger pool of borrowers -- is a more accurate reflection of banks' funding tensions.

Repurchase, or repo, markets allow financial institutions to borrow money in exchange for securities, such as government bonds, with an agreement to repurchase the collateral at a later date. When markets are functioning normally, rates for secured borrowing are lower than those for unsecured due to the lessened risk.

But current balance sheet constraints mean banks are less keen to hold collateral, preferring to hoard cash. And whereas refinancing on an overnight basis was a given a year ago, events such as the collapse of investment bank Bear Stearns in March have encouraged banks to lock in longer-term funding to lessen refinancing risk.

One-month secured lending rates, based on the Eurepo index -- the benchmark for secured money market transactions in the euro zone -- rose as high as 4.338 percent in July from 4.034 percent in early June.

Meanwhile the average spread over the European Overnight Index Average (EONIA) -- an effective overnight rate for unsecured borrowing -- rose to 8 basis points in July from a yearly average this year of 3 basis points, according to Reuters data.

"Repo is above eonia, meaning collaterized is trading above uncollateralized lending, which is expected for quarter-end because banks, in order to make their balance sheets look better, do not wish to hold assets that are not essential to their operations," said UBS rate strategist Achilleas Georgolopoulos.

"But the point is that it has continued, though the spread has narrowed, but it still remains and that is strange."