By Kirsten Donovan LONDON, Nov 28 (Reuters) - Indicators of funding stress for euro zone banks held at their highest levels since the 2008 financial crisis on Monday, increasing the likelihood of higher dependence on the European Central Bank into year end. The cost of paying to swap euros into dollars for three-months was well above those obtainable at the ECB's dollar swap operations ahead of next week's longer-term tender, suggesting demand may pick up. Meanwhile excess liquidity in the banking system was around 260 billion euros, according to BNP Paribas, with large amounts of that being hoarded, reflected in the high usage of the ECB's overnight deposit facility. That figure is not expected to drop much at the ECB's weekly tender on Tuesday, where 247 billion euros of funding matures, with a Reuters poll expecting banks to roll 240 billion euros over. "Money markets are going to stay under pressure into year end," said Morgan Stanley strategist Laurence Mutkin. "There is a lot of excess liquidity but the problem is how banks are going to address the value of the government assets on their balance sheets." Longer-term funding for euro zone banks has dried up on concerns over their exposure to the sovereign debt crisis, in turn pushing up yields demanded by those banks to buy T-bills issued by the region's debt-laden governments. Belgium's one-year cost of funding rose above the equivalent Euribor rate last week while the equivalent Italian and Spanish spreads have widened sharply during November, according to Morgan Stanley. "Sovereigns borrowing at Euribor-plus shows the market is unwilling to take-down (short-term) paper into year-end, representing a further deterioration in the sovereign credit/bank nexus," Mutkin said. Fitch's latest money market report, released last week, showed U.S. prime money market funds have reduced total exposure to European banks by 42 percent since the end of May with a big shift to shorter-maturity lending. For example, Fitch noted that more than half of U.S. money market fund exposure to French banks is now for a week or less, compared with just 7 percent at the end of June. That availability of short-term U.S. dollar funding may be one reason why only two banks have been using the ECB's one-week dollar swap line for around $500 million and it is still cheaper to obtain shorter-term dollar funding via the market. RBS calculates that it costs around 1.32 percent to borrow one week dollars from the ECB versus a current market rate of around 1.15 percent, but three-month dollars from the central bank cost 1.45 percent, now well below the current market rate of 1.80 percent based on a three-month cross-currency swap rate of around 150 basis points. That is the opposite situation to when the ECB held its three-month dollar tenders in October and November, meaning there may be an increase in demand at next week's offer of funding after a sharp widening of the basis swap last week. "A notable increase in demand for the December 7 tender is likely if the basis remains at this level or wider," said RBS strategist Simon Peck. "However, it is important not to ignore the negative stigma associated with accessing the dollar liquidity lines." With seemingly little prospect of the ECB stepping up its bond buying activities any time soon, next week's policy meeting will focus on whether the central bank takes steps to provide more longer-term liquidity. The ECB is looking at extending loans to two or even three years to try to prevent the euro zone crisis precipitating a credit crunch that chokes the bloc's economy, people familiar with the matter told Reuters last week. Access to longer-term funding may be crucial with senior financing markets all but closed since the middle of this year and around 800 billion euros needed for European bank refinancing, according to RBS.

Source