In absence of disclosure, European banks run for hills

Don't look now, but there is the modern day equivalent of a bank run going on in Europe.  As reported in a Wall Street Journal article, European banks are reducing their exposures to any bank or sovereign where there is concern about its solvency.

Regular readers know that bank runs occur in the absence of disclosure.  There is a change in belief about the bank's solvency.  When this occurs, investors and depositors have an incentive to get their money back before the bank collapses.

At a minimum, as predicted under the FDR Framework, the lack of disclosure is leading to a freezing of the interbank loan market.

Some of Europe's biggest banks are taking steps to shore up their defenses should the debt crisis spiral out of control and one or more countries leave the euro zone, a sign of the financial sector's increasing worries over the continent's plight. 

Some banks recently have been reining in some cross-border lending to companies in countries like Spain and Italy, bank officials say. Others are parking more money with the European Central Bank, according to ECB data. Banks also are increasing their use of credit-default swaps as protection against their holdings of sovereign debt from shaky countries. 

As the crisis deepens, even European central banks are considering the possibility that one or more countries could leave the currency bloc, according to people familiar with the matter, a scenario that until a week ago seemed to many as implausible. 

Overall, European banks appear to be growing increasingly wary of lending to each other, even on a short-term basis. Deposits parked at the European Central Bank's overnight deposit facility jumped Tuesday to €90.5 billion ($127 billion), up from €65.7 billion a day earlier. The last time the ECB's deposit facility was so flush was more than five months ago, on Feb. 7, when banks stashed €137 billion there. 

While the amount of funds parked in the ECB facility ebbs and flows over the course of each month for technical reasons, it has historically been a good proxy for how fearful banks are about lending to each other—and about the financial crisis intensifying. 

The moves reflect mounting concern that Europe's political leaders lack the will to adequately address the Continent's problems. The worries have shifted from concerns that Greece may default on its debts to a more dramatic scenario where Greece or another country departs the currency bloc. 

Although the European debt crisis has been dragging on for roughly a year and a half, it appears to have entered a new, more perilous, stage this week. Expectations have faded that European officials will be able once again contain Greece's problems and avoid a destabilizing default that would inflict losses on banks holding Greek debt. 

In the process, the spotlight has turned back to Italy and Spain's debt problems. Earlier in the year it had become conventional wisdom that despite economic and fiscal problems of their own, those countries had been walled off from Greece's woes. But the recent focus on Italy suggests that isn't the case. 

"Apart from the ECB, there are currently no big wallets in the EU that are capable of supporting Spain and Italy," said Willem Buiter, Citigroup Inc.'s chief economist. 

One senior London banker said his bank is drawing in untapped credit lines to companies in Spain and Italy. An official with another major European bank said it is considering similar moves, although it is nervous that such actions could send a destabilizing signal that the bank is in trouble. 

The departure of a country from the euro zone could expose banks with big operations in such countries to the risk of rapid currency devaluations and other turmoil. One banker said his bank was increasing its hedging to protect itself. An official at another bank said the situation in Italy is being monitored "moment by moment." 

The defensive moves have the potential to put further pressure on those economies by reducing the already limited supply of credit. This occurred at the outset of the U.S. financial crisis in 2008, deepening the recession. One official said the situation in Italy is being monitored "moment by moment." 

Officials at some banks said they sliced their exposures to at-risk countries more than a year ago and so new steps are unnecessary. Banks are also closely monitoring their funding positions, alert to the possibility that panicky depositors will start yanking funds from lenders connected to the euro-zone crisis, industry officials say. 

There are signs that some depositors, such as the U.S. money-market funds that represent a key source of funds for many European banks, are growing increasingly jittery. Officials with two relatively healthy European banks said they recently have been attracting more short-term deposits, despite the fact that they are offering ultra-low interest rates. The officials said the uptick in deposits is indicative of a flight to safety... 

In the U.S., a main gauge of stress in the credit market shows increasing worries about counterparty risk as the euro-zone debt troubles increasingly threaten to spill over into larger economies. The two-year U.S. swap spread, which measures the gap between swap rates and Treasury yields and is considered a prime indicator of risk aversion, widened to 0.30 percentage point, 0.015 percentage point wider from late Monday. 

Swap spreads often move in tandem with credit spreads and are a sign that traders think their partners in an interest-rate swap trade will fail to hold up their end of the trade. 

Part of the reason for the increased fears surrounding the continent's banks is that European regulators on Friday plan to announce results of their months-long "stress test" of 91 top lenders. Senior bank executives and regulators in several countries are worried the increased disclosures banks must make as part of the process could fuel market fears by casting their financial positions in a poor light, say people familiar with the matter. 

Disclosure does not cast a bank's financial position in a poor light.  Disclosure just shows what a bank's financial position actually is.  How the market interprets that position is what cast it in a good or bad light.