* Costs of borrowing soar in secured lending markets
* Analysts say that could jam up crucial source of funding
* Traders waiting to see details of ECB solution
By John Geddie
LONDON, March 17 (Reuters) - The soaring cost of borrowing government bonds in secured lending markets highlights the distortions caused by the ECB's asset-purchase scheme, which analysts say could clog up Europe's financial system.
Uncertainty over how the European Central Bank will counter the scarcity of top-rated debt could further shrink repo markets -- a source of funding that is essential to the smooth running of bond markets.
In repos, or repurchase agreements, short-term loans are offered in exchange for collateral such as government debt. Repos are crucial to the settlement of many bond transactions.
The ECB has said it will lend back to the market the trillion euros of bonds it buys in its quantitative easing programme. But with QE already under way, it is still unclear how that will work.
"It is pretty clear that the programme has been put into place as soon as possible, before all the operational details had been settled," said Peter Chatwell, a strategist at Mizuho. "This uncertainty means our funding markets are not operating as normal."
In the last fortnight, yields on even low-rated Italian and Spanish government general collateral -- the term used to describe a basket of assets eligible for repo -- fell into negative territory for loan terms of three months and more.
That means institutions are effectively paying a premium to swap cash temporarily for those bonds. Analysts say that illustrates the shortage of the bonds in the market.
Prices quoted by brokers, and seen by Reuters, also suggest banks can buy AAA-rated German Bunds at rates that make them ineligible for purchase under the ECB's scheme and repo them out at a handsome premium.
But bond traders told Reuters that even though prices were quoted in the market, they often could only find counterparties to repo out bonds for very short periods.
"This expensiveness in term repos shows how unwilling Bund holders are to depart from their collateral for more than a few days or weeks," said JPMorgan analyst Nikolaos Panigirtzoglou.
One broker said every German government bond eligible for ECB purchase was now trading 'special', meaning exceptional demand had made it more expensive to borrow for three months than general collateral.
These are the kind of market distortions that ECB policymaker Benoit Coeure said last week he hoped to alleviate with securities lending. Analysts are divided on whether that will address the broader liquidity squeeze.