European banks are also pulling back from other sources of short-term funding, such as the commercial paper market, as investors shun risks related to Europe

The latest wave of anxiety came after the Wall Street Journal reported the Federal Reserve is taking a closer look at the U.S. units of Europe's biggest banks on worries that the region's debt crisis could spread to the U.S. banking system.

Short-term money markets showed further signs of bank stress emanating from Europe's fiscal strains. The benchmark for unsecured dollar loans between banks, 3-month LIBOR, rose to its highest in 4-1/2 months, the latest in a series of such peaks.

Foreign banks reduced issuance of U.S. commercial paper in the latest week as investors became more anxious about the European debt crisis, Federal Reserve data released on Thursday suggest.

"A lot of flows have not returned to the interbank market. Most investors are not very comfortable right now," said Mike Lin, director of U.S. funding at TD Securities in New York.

The U.S. Federal Reserve Bank is treating foreign banks the same as their U.S. peers, a policymaker said, putting himself at odds with the report that it was keeping a closer eye on European banks struggling with the continent's debt crisis.

Fears about bank funding were one of the reasons for another dismal trading day for bank stocks in Europe after heavy losses in the last two weeks, with the main bank stocks index giving up 7 percent in late trading.

So far, those fears have not shut off funding for European banks entirely. They are still able to obtain dollars from money markets but their costs have been rising.

Still, the combination of fewer dollars and higher interest rates have severely pared activity in interbank lending.

Investors already started scaling back their exposure to European banks in the spring. They have reduced their holdings of commercial paper, certificates of deposit and other short-term debt issued by top European banks as the fiscal struggles in Greece and other weaker euro zone members flared up since the problem began a year ago.