FEARS THAT the European Central Bank (ECB) is scaling back emergency support to euro zone banks too soon sparked sharp falls in financial markets yesterday, with the euro tumbling to an 8½-year low against the Japanese yen.

Bankers warned that the ECB’s decision not to renew one-year loans to financial institutions had stoked concern about the ability of some euro zone banks to access interbank borrowing markets.

Key three-month euribor rates, which measure the cost at which banks are prepared to lend to each other, jumped to the highest level since September and the biggest one-day rise since April 28th. Euribor rates rose to 0.761 per cent from 0.754 per cent.

The ECB will today offer unlimited loans for three months as it seeks to ease the strains on those banks that must return €442 billion of one-year loans – the biggest amount lent in a single liquidity operation – tomorrow.

Bankers warn that the ECB’s decision is raising concerns that many institutions will come under further pressure in the strained interbank markets.

Don Smith, economist at Icap, said: “There are major worries over the systemic risks for banks, with many struggling to access the private markets. The ECB is in effect weaning the banks off the artificial support system – and this is a concern.”

Banks across the euro zone, and in Spain in particular, have found it hard to secure liquid funding in commercial markets. Spanish banks have been lobbying the ECB to ease the fallout from the expiry of the €442 billion in one-year loans it made a year ago. The unease among investors spread from Europe to the US, and sent share prices on Wall Street to their lowest in seven months.

European interbank rates jumped to their highest for nine months. The central bank wants to wean banks off its emergency funding programme. It is worried that providing additional 12-month loans will distort financial markets. It is confident that the repayment of the €442 billion will go smoothly.

“We will make sure that there are no problems and everything goes okay,” Christian Noyer, France’s central bank governor, told Europe 1 radio. But, he warned that “there are some banks that are in a less good situation that might eventually suffer”. – (Copyright The Financial Times Limited 2010)