Even the safest euro zone banks could start queuing up at the European Central Bank for cash in the next few months as their massive exposure to government debt freezes them out of money markets.

The pressure pushing banks' short-term funding costs higher could escalate quickly if the value of their sovereign debt holdings, which have already fallen sharply, take another hit when euro zone governments begin the tough task of refinancing huge amounts of borrowing early next year.

With no solution to the euro zone debt crisis in sight, interbank market players say they are reducing credit lines to an ever increasing number of banks.

It is utter madness ... When we see big names paying 300 basis points over overnight rates for dollars you know something is wrong, said the head of money markets at a bank in London, who asked not to be named.

Credit lines have already been reduced, we are seeing the big names paying through the nose for cash from corporates as wholesale is pretty much dead. The focus now is for the core banks to raise cash through the retail/corporate space. Central banks may be called upon.

Most banks based in the euro zone's most indebted states are effectively shut out of the money markets and banks in France -- seen as the weakest of the bloc's triple-A-rated core sovereigns -- are already being forced out one by one, traders said. Stress is also exacerbated by end-year liquidity needs.

French banks' borrowing from the ECB topped 100 billion euros in the maintenance period ending November 8, compared to 87 billion euros the month before. French banks are more exposed than any those of any other euro zone country to Italian, Spanish and Greek debt, with holdings in excess of 600 billion euros, according to Bank for International Settlements data.

Nikolaos Panigirtzoglou, European head of global asset allocation and alternative investments at JPMorgan, expects a pickup in Austrian banks' take-up of ECB cash in the coming months if no solution to the crisis is found.

He said funding strains for banks could seep deeper into the core as bond redemptions and interest payments in Italy, which has to pay some 100 billion euros between January and April, draw nearer.

For now in the expanded periphery we have Belgium and France, but it could go further, Panigirtzoglou said.

Citing increased challenges in financial markets, Fitch Ratings downgraded Goldman Sachs, Deutsche Bank and five other large banks based in Europe on Thursday.

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Euro 2012 supply and redemption schedules http://r.reuters.com/gev45s

Country-by-country bank exposure: http://r.reuters.com/vyj98r

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In such an environment liquidity is at a premium. Some investors are even taking money out of banks and paying to keep it in short-term German or Dutch government paper, which is trading with negative yields.

The worst case scenario (a euro zone break-up) was pretty much ridiculous a year ago but it is now becoming more and more possible, to say the least, Juan Valencia, credit analyst at Societe Generale, said.

People have already started to prepare for it, they are hoarding a lot of cash.

FREEZE

Of the contributors to daily Libor rates, French banks BNP Paribas, Credit Agricole and Societe Generale say they pay the most for three-month dollars, around 0.6 percent. But dollar rates have recently been on the rise for other core country banks as well.

Those costs are still sharply lower than levels close to 5 percent seen during the crunch triggered by the Lehman Brothers collapse in 2008 because the world's central banks have emergency liquidity measures in place this time.

To avoid stress levels reaching those seen three years ago, the ECB plans to pump unlimited three-year liquidity into the banking system on Wednesday.

Analysts say banks are more likely to use the money to pay their own debts rather than for the so-called carry trades, in which they would borrow at 1 percent from the ECB and buy Italian and Spanish debt yielding 6-7 percent.

That will leave the sovereign crisis unresolved and banks, although kept alive by the ECB, will still face funding strains.

It is not a sustainable solution. What we need is the sovereign crisis to end ... If a sovereign gets shut out of the market, it is pretty much game over, said SG's Valencia.

He estimates banks face about 320 billion euros in senior and government guaranteed debt redemptions next year. By comparison, they had issued just 12 billion euros of debt in the past six months, he said.

Valencia recommends investors in credit markets avoid financial institutions. Those who cannot, because financials are part of their investment indexes, should only invest in national champions, he said.

You have to be extremely selective ... if you have to stay with some financials you have to stay with the best.

(Graphics by Kirsten Donovan, Vincent Flasseur and Scott Barber, editing by Nigel Stephenson)

BNP Paribas European union