European bank funding and deleveraging

Following special policy measures introduced by central banks around the beginning of December, European banks' funding conditions improved. Previously, many banks had been unable to raise funds in the unsecured senior bond market, and the cost of unsecured money market funding had risen to levels previously exceeded only during the 2008 crisis. Dollar funding had become especially expensive. Two three-year lending operations (LTRO) by the ECB and a wider set of collateral than was previously eligible relieved much of the stress. Furthermore, the cost of swapping euros into dollars fell in December, as central banks reduced the costs of their international swap lines. Short-term borrowing costs then declined and unsecured bond issuance revived.

At their peak in late 2011, funding strains fuelled fears that European banks would be forced to sell assets and reduce lending, thereby weakening real economic activity. New regulatory measures requiring banks to meet more stringent capital standards by mid-2012 added to these fears. European banks did sell certain assets and cut some types of lending, notably those denominated in dollars and those attracting higher risk weights. But, as other lenders stepped in, there was little evidence of any major impact on either asset prices or lending volumes.