Eurosystem Heading Toward July 1 Liquidity Shock

June 16, 2010 (LPAC)—The mechanics of the euro system are grinding to a halt. The sovereign debt crisis is pushing liquidity to places considered "safe." Every night, banks of the eurozone deposit ever more funds at the ECB, even though the yield they get is only a miniscule 0.25 percent, because they do not trust the solvency of any of the other private banks enough to lend to them. On Monday morning, 384 billion euros were on deposit at the ECB — an astonishing figure, since this was only a few billion euros per day before the 2008 financial crisis. The current volume is even far higher than the volume deposited the week after the Lehman default.

At the same time, interbank lending is frozen. Saving banks are refusing to lend to commercial banks. Since May, writes Le Figaro, lending from European banks has simply stopped.

On top of that, in two weeks, on July 1st, European banks will have to repay the 442 billion euros they borrowed from the ECB's exceptional financing facility, opened up for them one year ago. The date of July 1 to exit the facility is a real subject of preoccupation for European banks, says Alain David, the executive financial director of French bank Banque Populaires-Caisses d'Epargne (BPCE).

European Banks have been putting money aside to pay back what they borrowed, but not all are ready to pay now. Spanish banks such as Sabadell and Banesto have only 35 percent of what's required, and Germany's Commerzbank only 32 percent. According to Morgan Stanley, European banks have found 250 billion thus far, and still need another 150. But July 1st is not the only major deadline for the banks. Before the end of the year, banks need to repay at least 560 billion euros, and with the imposition of the new Basel III accounting rules, that amount will increase to 1,500 billion euros.