What's more the take-up of dollar loans by the ECB under swap arrangements with the US Fed has been paltry, even though the LIBOR prices indicate that the peak of stress for banks is in the dollar funding market.

All a bit odd. Unless you think that what's going on is the reverse of the trends of 2007-8. It could be that this time a solvency problem is wagging the liquidity dog, rather than a liquidity shortage giving a good shake to the solvency dog.

Or to put it another way, it may be that what's persuading banks' creditors to demand a higher rate for their loans is the expectation that European banks' will suffer big losses on their holdings of assorted eurozone government bonds and their loans to assorted European property markets.
The rising price of Libor may be based on the belief that a possible default by the Greek government on its debts, or a further downward lurch in the value of Spanish property, could generate unsustainably high losses for a number of big European banks.

Or to put it another way, the LIBOR rise may be saying that the eurozone's fiscal crisis could be the precursor to the demolition of some substantial, thinly capitalised European banks.

Which would be the most worrying interpretation of the LIBOR rise.

There is however a more benign explanation.

The thrust of anticipated bank reforms - whether they're the Obama reforms or the increases in capital and liquidity ratios to be demanded of banks by the Basel Committee on Banking Supervision - are likely to have the effect of increasing the costs for banks of lending.

Eoin Treacy's view Apart from the issues raised in the above piece there is the additional question as to how much interbank lending has actually occurred over the last 18-months. The liquidity requirements for many institutions have largely been met by their respective central banks who granted unlimited access to credit. Some CBs have now begun to close this window but the interbank market is still a fraction of what it was before the credit crisis. This chart of US Aggregate Reserves of depository institutions in excess of what is required indicates that most banks continue to hoard cash, probably in an attempt to shore up their balance sheets. Why would a poorly capitalised bank lend to another where the balance sheet is at best opaque, when abundant credit is accessible through the discount window?.

The spread between the 3-month US$ LIBOR rate and the 3-month T-Bill (TED spread) and the Eurozone equivalent have a similar pattern. Today's spread is higher than at anytime in the last year but is not remarkable when compared to where it traded prior to 2007. The trajectory of these spreads suggests additional stress in the banking sector but is not currently at crisis levels. The uptrend remains reasonably consistent so we cannot dismiss the potential that the 100 basis point level will be taken out at some point, but that still appears to be quite away off. (Also see David's piece in Comment of the Day on May 18th).

If a liquidity crisis does develop we can make a fair guess as to how central banks will respond to such a situation: they will probably open the liquidity spigot, accept just about anything as collateral for loans and shore up bank balance sheets as needed. The TED spread is probably responding to weakness in the bank sector rather than vice versa so Bank sector indices are also worth watching. The Dow Jones Euro Stoxx Banks Index remains in a relatively consistent 9-month downtrend. While it is becoming increasingly overextended relative to the 200-day moving average, the Index continues to post new reaction lows and a sustained move back above 175 would be required to question the consistency of the decline.

The Euro also remains under pressure and broke below the October and March lows against the US Dollar today. The next area of potential support is in the region of $1.20 but a sustained move back above $1.2675 is required to question the consistency of the overall downtrend.