Key Takeaways
- The European Central Bank's (ECB's) new operational framework won't tighten conditions for banks to access central bank liquidity and should prove supportive of bank funding and profitability.
- It also does not imply any acceleration in the reduction of the ECB's balance sheet, although this is not ruled out either.
- The ECB left little room for a strong resurgence in money market transactions, and especially unsecured interbank lending, not least by announcing plans to reduce the spread between its main refinancing operations rate and the deposit facility rate to 15 basis points, from 50 basis points.
The European Central Bank (ECB) has finalized the review of its operational framework, which determines how it steers its monetary policy stance and therefore how it provides liquidity to the banking system. S&P Global Ratings believes that the ECB's announcement on March 13, 2024 will cement ample liquidity provision for eurozone banks for the foreseeable future, with positive impacts on banks' liquidity and funding conditions, and their profitability.
Banks main question had been: would the ECB announce a roll-back of (some) of the liquidity measures initially introduced to manage the 2008-2009 financial crisis? Those measures included a lowering of the minimum reserve requirements to 1% (from 2%) and the introduction of full allotment procedures in refinancing operations--i.e., the possibility for banks to receive as much central bank liquidity as they need against adequate collateral. There was also a possibility that the ECB would announce an acceleration of its quantitative tightening program, which could have accelerated deposit outflows.
The ECB was never likely to jeopardize eurozone banks' access to liquidity or the monetary policy transmission mechanism. Yet tweaks to the framework could have impinged on banks' funding costs and therefore profitability (see "Eurozone Banks: Higher Reserve Requirements Would Dent Profits And Liquidity,", Oct. 24, 2023, and "What An Acceleration Of Quantitative Tightening Could Mean For Eurozone Banks," Sept. 13, 2023).
No News Is Good News For Eurozone Banks' Funding And Liquidity
The ECB's new operational framework will not tighten conditions for banks to access central bank liquidity. The ECB intends to continue to steer its monetary policy stance by adjusting the deposit facility rate (DFR), as it has done for several years, through liquidity injections (see chart 1). To achieve that, it will serve banks' liquidity needs upon demand, employing a so-called "demand-driven floor system", similar to that used by the Bank of England. Essentially, the ECB has ruled out a return to the scarce-reserve systems that were prevalent before the great financial crisis, implicitly recognizing that banks' needs for liquidity are likely greater and harder to measure ex ante, especially in an era where bank runs can materialize quickly.
That is supportive of banks' funding conditions, not least because the ECB confirmed that it would continue to fully service their liquidity needs against the same pool of collateral assets and on the same conditions as before. The ECB additionally announced it will introduce long-term structural refinancing operations at a later stage. The ECB has not yet decided on the duration and conditions of these future operations.
Chart 1
The new operational framework does not imply any acceleration in the reduction of the ECB's balance sheet (see chart 2). There is no mention of bond sales, although the ECB does not rule out this possibility, but ties the issue to monetary policy rather than to the operational framework. In this context, it is likely that the ECB's balance sheet will continue to be gradually reduced, through the unwinding of Targeted longer-term refinancing operations (TLTROs) and the passive run-off of current bond portfolios. Accordingly, the ECB's balance sheet is likely to total at least €5,000 billion by the end of 2026, down from €6,800 billion today and a peak of €8,800 billion in the third quarter of 2022. For the banking system, that means the reduction in deposits induced by quantitative tightening will likely be very gradual and predictable.
Chart 2
The ECB also said it will consider a structural bond portfolio, probably once the current asset purchase program (APP) and pandemic emergency purchase program (PEPP) portfolios have run to maturity, after 2026. The ECB has yet to decide on the most important details of that initiative, namely the size, composition, and duration of the portfolio. The ECB's "constructive ambiguity" about size, composition and duration of its future bond portfolio has the power to contain a rise in European bond yields over the near future.
ECB's Decisions Are Also Supportive Of Banks' Profitability
The ECB announced no change to the level of minimum reserve requirements (MRR), which will stay at 1% of the combined total of deposits, debt securities, and money market paper held by each eurozone bank. Given that mandatory reserves are not remunerated, an increase in MRRs would have directly hit banks' income. Despite its mention that the operational framework should preserve its own financial soundness, the ECB did not consider that an increase in MRR was warranted to protect its financial standing by lowering the amount of interests it pays to banks.
The new operational framework is likely to prevent any strong resurgence in money market transactions, and especially unsecured interbank lending. Indeed, the ECB announced that, from Sept. 18, 2024, it will reduce the spread between its main refinancing operations rate (MRO) and the DFR to 15 basis points (bps), down from the current 50bps (see chart 3). Under the previous operating framework, implemented in 1999, that spread hadn't been tighter than 25bps.
The narrowing of the spread is intended to limit volatility on money market rates, and reflects the ECB's ongoing skepticism that money markets' can properly transmit its monetary policy. With such a narrow spread and given preferential conditions in terms of collateral and full allotment, we expect banks to have little incentive to turn to the interbank markets to meet their financing needs. What's more, the narrowing of the spread between the MRO and the DFR could encourage banks to hold eligible lower-quality assets (such as certain corporate bonds) and swap them for central bank liquidity, which could have a positive effect on credit spreads.
Chart 3
Related Research
- Top European Bank Rating Trends In 2024, Jan. 24, 2024
- Economic Outlook Eurozone Q1 2024: Headed For A Soft Landing, Nov. 27, 2023
- Eurozone Banks: Higher Reserve Requirements Would Dent Profits And Liquidity, Oct. 24, 2023
- Credit FAQ: What An Acceleration Of Quantitative Tightening Could Mean For Eurozone Banks, Sept. 13, 2023
This report does not constitute a rating action.
| EMEA Chief Economist: | Sylvain Broyer, Frankfurt + 49 693 399 9156; sylvain.broyer@spglobal.com |
| Economist: | Aude Guez, Frankfurt 6933999163; aude.guez@spglobal.com |
| Primary Credit Analyst: | Nicolas Charnay, Frankfurt +49 69 3399 9218; nicolas.charnay@spglobal.com |
| Secondary Contact: | Pierre Hollegien, Paris + 33 14 075 2513; Pierre.Hollegien@spglobal.com |
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