Eurozone banks are expected to repay almost 300 billion euros ($310 billion) in loans to the European Central Bank next week, the ECB said on Friday, and the largest cash withdrawal from the euro zone’s financial system in the euro’s 22-year history.
The move is part of the ECB’s attempts to combat all-time high inflation in the eurozone by increasing the cost of credit and it is its first step towards mopping up even more liquidity in 2023 by pruning its multi-trillion-euro bond portfolio.
Notably, the euro zone’s central bank said lenders would pay back 296 billion euros worth of the 2.1-trillion-euros, multi-year credit they have received under its Targeted Longer-Term Refinancing Operations (TLTRO) when they get their first opportunity to do so on Nov. 23.
This is below the half a trillion euros that analysts were expecting but still the largest drop in excess liquidity since records started in 2000.
The one-week ESTR rate, which gauges borrowing costs for banks after the repayment is approved, dropped after the ECB’s announcement, as did yields on Italy’s two-year government bonds, although briefly.
ECB policymakers will examine how the market digests this abrupt drop in cash to assess how fast they can continue with reversing the ECB’s 3.3-trillion-euro Asset Purchase Programme, which they will talk about at their Dec. 15 meeting.
ECB board member Isabel Schnabel said on Twitter:
“These sizeable early repayments reduce the Eurosystem balance sheet and thereby contribute to the overall normalization of monetary policy, which is needed to bring inflation back to target over the medium term.”
This is the first voluntary repayment window so analysts had warned that some bank treasurers may decide to wait until the next one on Dec. 21 to have greater visibility on the state of their balance sheet ahead of their year-end results.
“The December repayment window may well see larger repayments still,” said Frederik Ducrozet, Pictet Wealth Management’s head of macroeconomic research, estimating reimbursements of 900 billion euros at that window.
While this early TLTRO repayment is voluntary, the ECB has offered banks an incentive to wipe out those loans by taking away a rate subsidy in October.
The biggest impact from the reimbursements was likely to be seen in less developed countries, which would see a larger proportion of their government bonds return to the market after being locked at the ECB as collateral for the TLTRO loans.
The other major focus for the ECB is money markets, in which banks give loans to each other for a short time.
Those markets have been restricted by the ECB’s policy for years as banks could not get high-quality bonds to use as collateral for borrowing or did not have an incentive to do so when they could simply draw on TLTRO for subsidized loans.
Antoine Bouvet, a strategist at ING, said the lower-than-anticipated reimbursement “deals a blow to hope of near-term” relief in collateral scarcity.
He and Ducrozet both said the ECB may require to launch a new long-term funding facility for banks, even though on less generous terms, if banks come under stress.
($1 = 0.9647 euros)