A key source of liquidity for cash-strapped banks – the covered bond market – appeared to be closed off yesterday after trading between banks in the secondary market was officially suspended and the mortgage bank Abbey was forced to abandon a new issue of bonds.

Covered bonds, which are regarded as super-safe securities because they are not only secured against highly rated mortgages but also give the investor a further claim against the issuer, have been one of the few sources of fresh liquidity for banks since the credit crunch hit in August.

Interbank market-making of covered bonds was suspended until at least Monday by the Brussels-based European Covered Bond Council, an industry group that represents securities firms and issuers, in order to prevent a disorderly market.

“In light of the current market situation and in order to avoid undue overacceleration in the widening of spreads, the . . . Market-Makers and Issuers Committee recommends that interbank market-making be suspended,” the ECBC said. It said that market-making to investors would not be affected.

Spreads – the difference between the interest rate on the bond and interest on government securities – have ballooned in recent days, sending the prices of these bonds falling, and liquidity has dried up. Investors and market-makers are concerned that the issuing banks may face much larger losses on sub-prime mortgages and asset-backed securities.

Abbey, which is owned by Santander, said last night that it had explored the possibility of raising capital through a covered bond issue, but had found very poor investor appetite.

An Abbey spokesman said, “We did some premarketing. Investors could see we are very strong, but the market for securities backed by UK mortgages is very, very poor at the moment.”

Credit worries hit continental bank shares yesterday, with Société Générale marked 6 per cent lower. The DJ Stoxx index of European banking shares suffered its largest one-day fall for four years, sliding 3.3 per cent.

Credit analysts put a brave face on the shutdown order, saying that it was good for the market. Christoph Anhamm, head of asset-backed security research at ABN Amro in Frankfurt, said. “It gives the market time to think. Quite a substantial part of the recent spread widening, particularly in the last three to four days, was driven by the mechanics of the interdealer market making obligation.”

He suggested that the market could stay closed for weeks.

There are almost €1,000 billion of covered bonds outstanding, with German and French banks the biggest players in this once-popular market.

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