Markets fret, but chance of big bank crash slim

Bank of Spain's bailout of a small regional bank has brought back the specter of another systemic crash after the demise of Lehman Brothers in 2008, this time on concerns about the financial sector in the euro-zone's periphery.

But the conclusion is too hasty, analysts said -- and a recovery in markets since the middle of the week is confirming that view.

"We're not back to the crisis days of 2008. The banks are not going into this period of turmoil with anything like the balance sheet structure they had two years ago, they are in much better shape," said Simon Maughan, analyst at MF Global.

Not only have banks more capital and liquidity, there is also less economic stress. "We were heading into a recession in 2008, we're heading out of one now," Maughan added.

Interbank borrowing costs -- a much-watched gauge of the trust banks have in each other -- rose to a 10-month high this week, unsettling investors, but many blame the problem mainly on a shortage of dollars in the system rather than outright fear of a bank counterparty failing.

Another key risk indicator -- the spread between three-month dollar Libor and overnight indexed swap rates -- has hit 0.33 percent, three times its level a month ago.

But the iTraxx index for insuring financials' senior debt against default has narrowed sharply, to 157.5 basis points since hitting 176 bps on Tuesday.

The downturn in banking confidence stemmed from the Greek debt crisis. One in three economists polled by Reuters last week said Greece will restructure its debt in the next five years despite a far-reaching rescue plan.

If that happens, Europe's lenders could take a "haircut" of 30-50 percent, analysts reckon. French and German lenders are most exposed, with exposures of 75 billion euros and 45 billion respectively to government debt and Greek borrowers at the end of March.

But banks are nowhere near as vulnerable as they were at the start of the crisis, when massive debt portfolios turned toxic forcing massive writedowns of ultimately more than $1.1 trillion globally.

They have largely dealt with structured investment vehicles and other off-balance sheet entities that they were suddenly forced to take on their balance sheets.

FUNDING COST HIKE

The concerns about exposure have seen higher costs for European banks accessing short term U.S. dollar commercial paper markets, making it more expensive for them to fund their day-to-day operations.

Ultra-conservative money market funds have already cut their exposure to Greek banks and other banks inside and outside the euro zone core are seeing a decline in commercial paper, a common short-term funding tool, data shows.

European banks' commercial paper market borrowing stood at $277 billion on Thursday, down 8 percent from the end of March. Borrowing by Spanish banks was down 13 percent during that time to $58.4 billion, according to data from Dealogic.

Spain's big two banks, Santander and BBVA, were the two biggest European bank issuers of commercial paper in the first quarter 2010, and worries about a squeeze in funds rattled investors.

But they have been attracting funding diverted from the embattled cajas, or small regional banks.

Santander raised 30 billion of new deposits in the first quarter. It also issued 15 billion euros in debt in the same period, meaning it has already raised funds well in excess of the 29.5 billion of debt maturing in 2010.

The rise in funding costs makes capital and liquidity more costly for banks just as regulators are piling pressure on them to increase their buffers.

But the European Central Bank's exceptional funding programs "means that we do not think that there will be a systemic funding crisis as there was in late 2008," said Andrew Lim, analyst at Matrix.