The euro funding gap and its consequences

A. Kaltenbrunner, D. Lindo, J.P. Painceira, Alexis Stenfors

    Research output: Contribution to journalArticlepeer-review


    During the spring of 2010, financial markets in the eurozone started to signal a re-awakening of the global financial crisis. As the euro sovereign debt crisis gained momentum, the euro embarked on a steep slide, and government bond and credit default swap (CDS) spreads started to rise dramatically, reaching levels not seen since the introduction of the common currency.

    Further, renewed pressures in the money market pushed up London Interbank Offered Rates (Libor), as banks became reluctant to lend to each other - fuelled by the uncertainty about each other's exposures to peripheral European countries and what the effects of the fall in prices of sovereign bonds might have on their balance sheets when marked-to-market. Libor-OIS spreads (both for dollar and euro loans) started to widen again, after a long period of narrowing following central banks' injections of vast amounts of liquidity into the banking systems in the aftermath of the Lehman Brothers collapse. Arguably even more importantly than Libors, both the FX swap and the cross-currency swap markets started to indicate serious strains in the interbank lending market for dollars. As the latter involves real cash, ie, physical exchange of notional often with dollars on one side, it is a better gauge for the relative demand of the currency than the indicative and non-binding Libor setting process.

    These strains were a symptom of European banks being unable, or having to pay a high cost, to fund their activities in the United States, which had surged since the launch of the euro. With the European Central Bank (ECB) unable to offer dollars, and the Federal Reserve unable to lend dollars directly to European banks, dollar swap lines were, as in the case of Lehman Brothers, yet again set up to protect the health of the banking system. The drivers this time were different, however, as we shall explore.
    Original languageEnglish
    Pages (from-to)86-91
    JournalCentral Banking
    Issue number2
    Publication statusPublished - 23 Nov 2010


    • euro
    • Eurozone
    • European Central Bank
    • Federal Reserve
    • Dollar


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