European banks, unlike their US counterparts, borrowed heavily from other banks to fund a spurt in lending to companies in the run-up to a global credit crunch, the Bank for International Settlements said. The scale of borrowing may have exacerbated the credit crisis as banks scrambled to roll over short term-funding when liquidity started to dry up over the summer.
Net borrowing by European banks from other banks, including uncollateralised loans and repo financing, has soared to $800 billion from practically nil in 1997, the BIS said in a quarterly review.
In contrast, US banks have borrowed in dollars from companies other than banks and channelled these funds to other banks through the interbank market. By the end of September 2007 total lending by US banks to other banks had shot up to $442 billion from virtually nothing in 1999.
"These diverging positions of US and European banks suggest that the latter face relatively large US dollar funding requirements, which may help in understanding the liquidity squeeze in the interbank market during the second half of 2007," said the BIS.
While European banks may have hedged their risks, the build-up in interbank borrowing to fund dollar lending to companies "may have required a frequency of rollovers in the interbank market that became difficult to maintain as market tensions increased," said the BIS report.