Banks say the European Central Bank may need a new funding program to help lenders make large repayments on pandemic-era loans without roiling the region’s money markets.
(Bloomberg) — Banks say the European Central Bank may need a new funding program to help lenders make large repayments on pandemic-era loans without roiling the region’s money markets.
The ECB is set to call in around €500 billion ($550 billion) in cheap loans made to prop up the economy during the pandemic, in the biggest such redemption. Around a third of these — originally doled out at sub-zero rates — are held by Italian banks, which Societe Generale SA strategists think don’t have sufficient excess reserves to meet the repayments.
That’s leading some traders to bet the process could drive up funding costs in Italian bonds. Some market watchers say the ECB may need a bridging loan to minimize the impact, with credit conditions in the region already tightening more than expected in recent months after interest-rate hikes and stress in the banking sector.
“In the wake of renewed focus on bank funding conditions, we believe that the ECB is now more likely to consider a bridge operation,” said Morgan Stanley analysts including Chiara Zangarelli. “The May meeting would be a good time to do so, to give banks time to prepare and maximize the market stabilizing role of the operation.”
The issue underlines the challenges of reducing banks’ reliance on an overall €4 trillion in excess liquidity, which is more than double the pre-pandemic level. ECB policymakers are meeting on Thursday, with their next June gathering coming just before the targeted longer-term refinancing operation (TLTRO) loans mature.
Excess liquidity in the region bulged close to €5 trillion last year, buoyed by the ECB’s bond-buying operations and loans to banks. It has since begun to fall but remains well above its norm for most of the last decade.
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The amount of money in the system made funding easy for European financial institutions, and warped repo rates amid a scarcity of collateral relative to cash. Yet the upcoming TLTRO repayment is causing some to brace for a reversal.
Rabobank sees “merit in a backstop LTRO in order to reduce the risks surrounding banks transitioning back to market-based funding,” said analysts including Richard McGuire.
An ECB survey published this week showed banks in the region curbed lending more than anticipated in the first quarter and saw a deterioration in their access to money markets. Lenders expected the impact on market financing conditions and liquidity to continue to be negative over the next six months.
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Rather than a bridging loan, Societe Generale’s head of rates strategy Adam Kurpiel expects the ECB to narrow the gap between deposit and refinancing rates to ease the burden on Italian banks.
“I believe this week is a good option to do it,” he said.
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