Eurozone: Minimum reserves debate reshapes liquidity – ING

ING strategists Benjamin Schroeder and Michiel Tukker discuss how a potential increase in the Minimum Reserve Requirement (MRR) by the ECB could tighten Eurozone liquidity and reduce ECB losses. They highlight uneven distribution of excess reserves across countries and banks, and warn that accelerating the move to lower excess reserves risks disrupting the ECB’s gradual monetary policy transition.

ECB liquidity framework and MRR risks

"Reuters reported yesterday that the ECB was considering raising the amount of reserves banks are required to hold at the ECB on average – not immediately, but potentially in autumn. Crucially, this Minimum Reserve Requirement (MRR) is not remunerated, unlike reserves parked at the deposit facility, which currently earns banks 2.25% in interest. Doubling the MRR is estimated to save the ECB close to €4bn annually, and more if interest rates were to be increased further."

"With excess liquidity currently at €2.2tr, the impact of a €174bn one-off reduction, which the doubling of the MRR would effectively result in, could be expected to be marginal. It would push us closer to a level of excess liquidity where funding rates are anticipated to react more sensitively to any changes, though. And we saw market expectations of Euribor/OIS spreads already nudge slightly higher on the back of the headlines."

"On a country level, we can see that Italy, Spain and Portugal hold excess liquidity to the tune of 3 to 6 times their respective MRR, whereas we are looking for multiples close to 15 for e.g. France and Germany. One could argue that redistribution of liquidity within the Eurosystem is currently happening relatively smoothly, but certainly some jurisdictions would feel a greater squeeze."

"Liquidity is also not distributed proportionally across banks, as had been pointed out in the discussions when the ECB first floated the idea of increasing the MRR, back then by even more than just doubling it. Crucially, those banks that hold the excess liquidity are not necessarily the ones holding deposits, which ultimately serve as a basis for the calculation of a bank’s MRR. And those banks holding disproportionally larger deposits tend to be smaller banks that would then be penalised."

"The ECB’s endgame remains to get to a situation where the banking system operates with lower levels of excess reserves, at levels determined by banks themselves in a self-balancing manner, with the ECB liquidity operations seen becoming an integral part of banks’ liquidity planning. The result is higher short-term market funding rates closer to the MRO as we see more reliance on the ECB's liquidity operations. The more structural liquidity needs would be covered by long-term liquidity operations and a bond portfolio (but substantially smaller than now)."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)