Reuters: ECB to start a major withdrawal of liquidity from the banking system

18 November 2022 253
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Source: Reuters

Author: Francesco Canepa

Article: Original article

Date of publication: Friday, November 18, 2022

The European Central Bank is going to make the largest liquidity withdrawal from the banking system it has ever seen. The event is planned for Friday, pushing banks to repay hundreds of billions of euros in ECB loans.

The move comes as part of the ECB's efforts to combat an all-time high inflation rate through increasing borrowing costs. This would lead to greater liquidity reductions next year driven by a several trillion euro cut in the ECB's bond portfolio.

The regulator is expected to reveal how many loans the banks will repay out of the total of 2.1 trillion euros ($2.17 trillion), being borrowed under the Targeted Long Term Refinancing Operations (TLTRO).

Although the early repayment of TLTRO is still optional, the ECB offered banks a way to get rid of those loans after it eliminated the interest rate subsidy last month.

Experts anticipate that banks are going to redeem about half a trillion euros worth of TLTRO loans, making it the largest liquidity fall since the start of the statistics in 2000.

ECB policymakers want to see whether the market digests this liquidity fall, so they can assess the speed of canceling the ECB's 3.3 trillion-euro asset purchase program, to be discussed at their meeting on December 15.

Most of the effect will be in peripheral countries, with the majority of government bonds returning to the market after being locked up by the ECB as collateral for TLTRO loans.

Louis Arraud, a strategist at Credit Agricole, said countries including Italy, Spain, Portugal and Greece will suffer more due to these changes. Germany and France are going to be less affected. However, southern European banks had fewer stimulus to repay debts since their reliance on TLTROs for funding was greater than its northern counterparts.

The ECB is also focused on money markets, where banks give loans to each other on a short-term basis. These markets have been constrained by the ECB's course over the years as banks failed to find high-quality bonds as collateral for borrowing. 

Any repayment of TLTRO worth more than 500 billion euros would reduce fears of a collateral shortage, but it would also raise the rates charged by banks. This is reported by Antoine Bouvet, a strategist at ING. If the TLTRO’s refunding leads to certain signs of stress in the money market, the ECB may decide to introduce a new mechanism as a substitute for TLTRO with less generous terms.

However, Marco Brancolini, a strategist at Nomura, said that there is "no great impact" even if the banks pay out 600 billion euros. He pointed to an ECB survey conducted last April. While 56% of banks said they used TLTRO funds to extend credit to the non-financial private sector, 44% reported that a share of those facilities had also been deposited back into the ECB.

The share of loans should be repaid with reduced impact on the economy, as Brancolini noted. Only a limited amount of TLTRO funds has been used to buy bonds. Banks seem unlikely to unwind these positions. In fact, it would lead to fixing losses shortly before the year-end.

Analysts reported that the upcoming loan repayment window is set for December 21, meaning some banks could hold off on making any moves until then.

Forecast: EURJPY is expected to rise.

This content is for informational purposes only and is not intended to be investing advice.

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