September 20, 2011

China Stops FX Swaps With Some European Banks

Debt crisis taking toll on Chinese foreign exchange market

Bank of China and another Chinese bank have stopped interest rate swaps and foreign exchange trading with a number of foreign banks, reducing their exposure to the eurozone.

Reuters reported Tuesday that the action was taken in the wake of the unexpected downgrade by Standard & Poor's of Italy late Monday. Unnamed sources cited by the report, including one at the second unidentified bank, identified only Societe Generale, Credit Agricole and BNP Paribas as some of the European institutions affected. French banks, in particular those three, have come under fire in recent weeks for their heavy exposure to Greek debt.

One sources told Reuters that Bank of China's decision might reach into its branches as well as the mainland bank, and include the onshore foreign exchange market. Another source was quoted saying, "Apart from spot trading, all swaps and forwards trading [with the European banks] have been stopped."

Bank of China has also stopped trading with UBS AG in the wake of its $2.3 billion loss in unauthorized trading, uncovered just last week, as reported by AdvisorOne.

Asian and other banks have been cutting credit lines and reducing exposure to European banks over the past few months as the threat of a default by Greece looms ever larger. That has sent European banks to the European Central Bank in search of ways around the high cost of dollars and worries about interparty risk that is pervading the interbank lending markets.

A strategist at a Japanese bank in Singapore, who requested anonymity because he is not authorized to speak to the media, was quoted saying, "Bank of China's move only highlights what has been a general trend in the interbank markets over the past few weeks: namely, some European names are finding it difficult to raise dollars and counterparty confidence in them is evaporating quickly. The selling in Asian credits, local debt, FX are all symptoms of them trying to create dollar funding buffers. While I don't expect this to have a material impact on their P&Ls, it just underlines how fragile broad market sentiment is."

While brokers said counterparty concerns had not yet affected trading, thanks to rerouting through willing third parties, they acknowledged that it could eventually take a toll on banks.

One unnamed dealer was quoted commenting about the FX swaps, "With so much bad news coming from Europe, I think more banks will follow suit."

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