You're reading: European bank stocks battered by liquidity fears (updated)

PARIS (AP) — European bank stocks tanked Thursday as fears about the institutions' ability to get access to funding and concerns over the anemic pace of the global economic recovery intensified.

Most bank stocks across Europe were underperforming in already fragile markets, with British bank Barclays and French bank Societe Generale leading the way down, ending the day with losses of 11.5 and 12 percent, respectively. Germany’s Commerzbank fell 10 percent.

Analysts said the plunge seemed to be, at least in part, a reaction to increasing signs that banks are struggling with liquidity — or access to the cash they need to run their day-to-day operations. Banks typically fund their activities with very short-term loans, and the seizing up of the credit markets where they get those loans was one of the hallmarks of the 2008 crisis. First banks refused to lend to one another, and eventually companies and consumers weren’t able to get loans.

A number of European banks are already dependent on last-resort credit from the European Central Bank because of a reluctance among financial institutions to lend to one another since many are heavily exposed to bad debt like that of Greece, Portugal, Italy and other foundering countries.

The European Central Bank said Thursday that one bank had borrowed $500 million a day earlier for seven days through the bank’s dollar lending program at 1.1 percent. The bank was not identified.

A request for dollars from the ECB suggests that at least one big bank is having trouble obtaining funds. Analysts said fears about one bank’s troubles are enough to spark concerns about the entire industry because traders are already worried about banks’ sovereign debt holdings.

"These are worrying signs," said Neil MacKinnon, an economist at VTB Capital in London. "You could think of it as a mini-Lehman moment: There is the risk that a major eurozone bank might be a casualty."

In 2008, the investment bank Lehman Bros. filed for bankruptcy, causing the global credit markets to freeze up almost overnight. Banks refused to lend to each other because they feared more failures and greater losses. Companies and consumers were unable to get loans.

Last week the European Central Bank opened its credit window and let banks borrow as much as they wanted for six months, an unusually long time that gives them more certainty about their funding. The ECB allotted 114 banks €49.75 billion, more than expected.

Part of the reason markets are responding so violently to whispers, like the news that a bank had tapped the credit window, is that banks across Europe hold large amounts of Greek debt, but no one knows exactly how much.

Fears of a potential default by Greece intensified on Thursday after at least five countries demanded that the Greek government give them cash as collateral in exchange for their contributions to its bailout.

Finland struck a deal with the Greek government on Tuesday to receive cash as security for its part of the rescue. On Thursday, the Netherlands, Slovenia, Austria and Slovakia demanded similar terms.

As Greece sets aside more money as collateral, the government there has fewer options for digging out of its debt hole. The amount of cash needed to satisfy the five lender nations probably is not enough to scuttle the bailout entirely, but it could drive up the overall cost of the bailout.

In a move that could compound liquidity fears, U.S. regulators said they were stepping up scrutiny of European banks’ U.S.-based subsidiaries, according to two people familiar with the situation. Banks are meeting more frequently than usual with supervisors from the Federal Reserve Bank of New York and the New York State Banking Department, said the people, who spoke on condition of anonymity to discuss confidential matters of bank supervision.

Analysts said that regulators are pressing the foreign-based banks to park more of their dollars in the U.S., in case their European parents falter and start draining them. Federal Reserve data show that foreign-based banks are storing more cash here — $127 billion near the beginning of August, up from $86.1 billion in June.

A similar spike occurred before the 2008 crisis, analysts with Keefe, Bruyette & Woods said in a research note Thursday.

While there are echoes of the 2008 crisis, Mark Pawlak, an analyst at bank research firm Keefe, Bruyette & Woods, cautioned that banks are in much better shape now. But with the memory of the cash crunch is so fresh, it takes less to get investors worried now. The problem, he said, was that these fears tend to feed on themselves, creating liquidity problems where few existed before as banks decide to hoard money instead of lending it to each other.

"Any signs of a funding crisis brings back horrific memories," Pawlak said. "There’s this visceral reaction."

Plunging stocks are not the only sign that investors are pulling back from European banks. They are also charging more to insure the banks’ bonds against the risk of default.

Peter Tchir, a former trader who now runs the hedge fund TF Market Advisors, said the cost of insuring European bank debt has widened sharply in the past week and rose again today. The cost of insuring U.S. bank debt increased only about half as much, he said.

One reason: It’s the first time that any bank has tapped the ECB facility, which has been in operation for nearly six months. Tchir said that has spooked traders.

It is "disconcerting that they chose to get it in a very public way," instead of paying a slightly higher rate to borrow dollars in the open market.

Poor economic news in the U.S. also seemed to be driving the flight from banks, which was also seen on Wall Street. Shares of big U.S. banks plunged faster than the broader market indexes. Bank of America Corp. and Morgan Stanley dropped about 7 percent, while Citigroup Inc. skidded nearly 9 percent. The Dow Jones industrial average was down more than 4 percent.

"People are putting the pieces together," said Will Hedden, a sales trader with IG Index.

Some of those pieces are an increase in claims for unemployment benefits in the U.S. and Morgan Stanley’s decision to cut its global growth forecasts for 2011 and 2012. Many European banks hold substantial amounts of Greek debt, and have begun to take writedowns on those holdings.

Banks have also been undermined by Tuesday’s revelation from German Chancellor Angela Merkel and French President Nicolas Sarkozy that the two countries’ finance ministers would come up with a proposal to slap a tax on all trading transactions.