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European debt crisis may flood U.S. banks with unwanted money

NEW YORK — The European debt crisis is poised to flood U.S. banks with something they don't want and can't use: more money.

Cash held by U.S. banks surged 8.4 percent to a record $981 billion during the week ended July 27, the Federal Reserve said Friday. That's more than triple the amount they had in July 2008, before the collapse of Lehman Brothers almost froze bank-to-bank lending.

Even more money may be deposited with U.S. lenders if investors pull away from European banks amid concerns that the Greek debt crisis will spread to Italy or beyond, said Brian Smedley, a strategist at Bank of America Merrill Lynch in New York. Those funds may not be so welcome: With few opportunities to lend them out profitably, U.S. lenders may have to slap fees on depositors to keep returns from eroding.

"At the margin, they have to think, 'What can we do with $50 million of deposits?' The answer is not much," said Bert Ely, a bank industry consultant in Alexandria, Va.

Bank of New York Mellon, the world's largest custody bank, announced plans last week to charge institutional clients for balances above $50 million. In a letter to customers, the bank said it's "taking steps to pass on costs incurred from sudden and significant increases in U.S. dollar deposits" linked to events including the Greek crisis and the uncertainty over the U.S. debt-ceiling debate.

The increasing reluctance of European banks to lend to one another has been on display since early last week. The so-called Euribor-to-Overnight-Indexed-Swap spread, which reflects the comparatively higher risk of lending euros for three months rather than overnight, widened to 0.57 percentage points Monday. The rate was 0.36 at the start of last week and 0.32 a year ago.

In contrast, the U.S. Libor-OIS spread — a stress barometer for dollar-based bank-to-bank lending markets — stood at 0.19 percentage points Monday, down from 0.24 a year ago.

Among the world's biggest banks, nine of the 10 perceived as the most likely to default are European, data compiled by Bloomberg show.

The relative ease in dollar interbank markets stems partly from the $2.3 trillion the Fed has pumped into global financial markets since November 2008 through its purchases of Treasury notes, mortgage bonds and agency debt. Fed balances stood at $1.62 trillion as of Aug. 3, up from $1.05 trillion a year ago.

Since late 2008, the Fed has been paying interest on deposits placed with the central bank, known as interest on excess reserves, or IOER. That rate is currently set at 25 basis points, or 0.25 percent.

At that rate, banks may struggle to profit from even noninterest-paying deposits because the companies must pay premiums to the Federal Deposit Insurance Corp. when they route the money to the Fed.

European debt crisis may flood U.S. banks with unwanted money 08/08/11 [Last modified: Monday, August 8, 2011 9:12pm]
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