Federal regulators are intensifying their scrutiny of the U.S. arms of European banks amid concerns about those institutions' abilities to fund themselves, according to people familiar with the matter.
The Federal Reserve Bank of New York, which oversees the U.S. operations of many large European banks, recently has been demanding more information from the banks about whether they have reliable access to the funds needed to operate on a day-to-day basis, these people said.
The concerns come amid turbulence in foreign banks' U.S. funding positions, which have fluctuated wildly in recent months, according to Federal Reserve data. The Fed's goal is to avoid a repeat of recent crises during which banks were unable to gain access to enough dollars to pay maturing debts.
The regulators' heightened attention signals a growing concern Europe's financial crisis could destabilize the U.S. banking system.
Regulators would be on watch because a "danger would be loss of liquidity for certain large banks, particularly in Europe, that depend critically on access to large quantities of dollars," said Darrell Duffie, a derivatives expert and finance professor at Stanford University in California. Mr. Duffie said that could spill over into the currency markets and cause large price movements.
While U.S. banks have relatively small exposures to the risky government and bank debt that is at the heart of Europe's woes, some of the Continent's biggest banks have major operations in the U.S. In particular, many European banks run big trading businesses in the U.S. that use dollars to fuel borrowing and lending. Typically, the banks try to match the flow of loans to the flow of debt the banks owe. Problems can occur if banks can't renew the debt or if money moves too fast to be tracked.
Foreign banks that lack extensive U.S. branch networks have a handful of ways to bankroll U.S. operations. They can borrow from money-market funds, central banks or other commercial banks. Or they can swap their home currencies, such as euros, for dollars in the foreign-exchange market. The problem is, most of those options can vanish in a crisis.
Until recently, that hadn't been a problem. Thanks partly to the Federal Reserve's so-called quantitative-easing program, huge amounts of dollars were sloshing around the financial system, and much of it landed at European banks. But that program has ended.
Fed officials recently have held extensive meetings with U.S.-based executives from top European banks to discuss their funding positions, according to the people familiar with the matter. Officials also are in contact with regulators in the countries where the European banks are headquartered.
The Fed officials also are trying to guard against the possibility European banks that encounter trouble could siphon funds out of their U.S. arms, leaving them stranded with financial holes, these people said. Regulators recently have amped up pressure on European banks to transform their U.S. businesses into self-financed organizations that are better insulated from potential problems with their parent companies, a senior bank executive said.
Officials at the New York Fed "are very concerned" about European banks facing funding difficulties in the U.S., said a senior executive at a major European bank who has participated in talks with the Fed.
In one sign of how European banks may be having trouble getting dollar funding, an unidentified European bank on Wednesday borrowed $500 million in one-week debt from the European Central Bank, according to ECB data. The bank paid a higher cost than what other banks would pay to borrow dollars from fellow lenders. It was the first time that type of borrowing had occurred since Feb 23.
Anxiety about European banks' U.S. funding comes amid broader concerns about whether the Continent's struggling banks will be able to refinance maturing debt in coming years. Investors, wary of many European banks' holdings of debt issued by troubled euro-zone governments, are shunning large swaths of the sector. While top European banks already have satisfied about 90% of their funding needs for 2011, they still need to raise a total of roughly EUR80 billion ($115 billion) by the end of the year, according to Morgan Stanley.
Part of what is unsettling regulators and bankers is the speed at which funding can reverse direction. This spring, foreign banks were able to build up ample cash cushions, thanks largely to the Fed's $600 billion bond-buying program, which brought more money into the banking system in the U.S., including foreign banks' coffers.
In July 2010, non-U.S. banks had $418.7 billion on reserve and collecting interest at the Fed, according to Fed data. By July 13 of this year, the total had more than doubled, to about $900 billion.
In recent weeks, though, the cash piles at foreign banks' U.S. arms have diminished. While individual banks haven't reported data after June 30, foreign banks' overall U.S. cash reserves fell to $758 billion as of Aug. 3, the latest data available.
