Money markets spanish downgrade piles pressure on banks

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* Downgrade likely to hike repo costs for Spanish banks* Spanish banks seen increasingly reliant on ECB cashBy Emelia Sithole-MatariseLONDON, June 8 Fitch's credit rating downgrade of Spain compounds funding problems for the country's struggling banks which may leave them even more reliant on the European Central Bank's cheap loans. Fitch slashed Spain's credit rating late on Thursday, leaving it just two notches short of junk status. It signalled more downgrades could follow as expectations grew Madrid would ask the euro zone for help with recapitalising its stricken banks. Cuts to individual Spanish banks' ratings are due to follow, which could complicate their use of repurchase markets which have been an important source of short-term cash. Many of the big Spanish banks use clearing houses to reduce the risk and cost of repo trades using government bonds but the ratings downgrade will boost the cost, or the initial margin clearers require to offset risks.

"This means that for a number of banks...(that) clear through LCH. Clearnet the financing will become much more expensive through repo and it's possible that some banks will not be allowed to clear if they fall below BB+," said Don Smith, an economist at ICAP."LCH uses the most conservative of the ratings so this will have an impact of raising, if not immediately but after a short period, the cost of repo financing to banks which increases their reliance for short term funds from the ECB," he said. Already earlier this week, banks' use of the ECB's weekly funding more than doubled as Spain's troubles left its institutions increasingly dependent on central bank support and as four Greek banks returned to mainstream ECB operations following a two week ban.

The ECB's weekly offering of limit-free 7-day funding saw a total of 96 banks take 119.4 billion euros, the highest since the second of its two 3-year injections at the end of February and more than double the 51.2 billion euros taken a week ago. BANK RESCUE DETAILS EYED

Spanish banks have increasingly seen their access to funding markets shrink as they slid deeper into a crisis caused by a burst real estate bubble and the country's deteriorating fiscal situation."Effectively they were already locked out of the it's not of huge concern as they were prevalent in tapping the ECB's liquidity operations," said Suki Mann, a credit strategist at Societe Generale."The latest downgrade doesn't help and it will mean they will need accommodative policy from elsewhere either from the ECB or some form of aid from the troika for the recapitalisation.". The cost of insuring against a default by the country's banks jumped after Fitch's downgrade of the country's rating, with five-year credit default costs for Banco Santander rising by eight basis points to 412.5 bps while those for BBVA were up five bps at 447.5 bps, according to provider Markit. Both Smith and Mann said they would wait to see the details of any planned Spanish bank rescue to see how far it would go in tackling the sector's problems.