No 157 - 29 June, 2010 I2
liquidity experienced by the Eurozone could give way toa liquidity shortfall
. As we go on to explain, this will nothappen and measures are being taken to prevent thechangeover from being too chaotic.
Benefit for the banks of participating in 12 –month LTRO
The 12-month LTRO was arranged when the interbankmarket was experiencing very serious strains andanticipations regarding short rates were clearly on the upside.Much of the EUR 442bn allocated to 1,100 banks must beanalysed as a desire to benefit from this windfall by locking inliquidity at 1%. This is in stark contrast to the situation now.
Liquidity will remain abundant even after withdrawingEUR 442bn
The EUR 442bn of collateral released when the 12-monthLTRO expires will not vanish into thin air. This collateral couldbe recycled at the weekly MROs (kicking of this week with a6-day fine tuning operation), which are being done at a fixedrate and for unlimited amounts, also at the 3-month LTROscheduled for 1 July. One can therefore expect theseoperations to be well bid.Accordingly, the 6-day FTO, 3-month LTRO and MROs arelikely to balloon in size. Banks will need time to see how bestto employ the collateral lodged for the last year at theEuropean Central Bank.That was the case at yesterday’s MRO maturing on 7 July, away therefore of anticipating the redemption, whenEUR 162.9bn was allocated to the 157 bidding banks.In terms of size, the MROs are likely to exceed EUR 200bn,and the 3-month LTRO could well approach this level (resultsdue to be released today at 11.20 am).
How to apply the collateral retrieved?
One can expect part of the collateral scraped together by thebanks last year will now find its way back into the market.
is unlikely to find its way back to theEuropean Central Bank, and while it may take several weeks,it will probably be sold or used in interbank repo market.In this respect, the European Central Bank’s own liquidity islikely to decline. On the other hand, liquidity in the interbankrepo market could increase.Banks, notably in Greece, Portugal, Spain and some inGermany, that are finding it hard to obtain refinancing, willcontinue to seek refinancing not in the interbank market butat the European Central Bank by lodging each week thecollateral retrieved when the 12-month LTRO matures.Several scenarios can be envisaged (see below). One canimage there being no rolls from the 12-month LTRO into theMROs and for demand to reach EUR 150bn at today’s MRO,but the most likely scenario in our view is that there will be apartial roll today through the 3-month LTRO and the MROscould be increased up to EUR 200bn. If EUR 150bn isallocated at the 3-month LTRO and MROs were once againto average EUR 250bn, there would once again be significantexcess liquidity compared with theoretical requirements(frozen at current levels for this purpose).This may appear a little optimistic but the reality is likely to besomewhere between these two extreme scenarios, witharound EUR 100bn of excess liquidity probably left in thesystem.
Excess liquidity will be reduced, possibly by EUR 150-200bn, but excess liquidity there will still be
The European Central Bank clearly does not want to imposerestrictive conditions given the strains experienced by theinterbank market and the effects this is having on certainbanks and certain countries.
Could the end of the 12-month LTRO cause a widening ofsovereign spreads?
Clearly, the impact will not be a tightening but rather awidening.While it is difficult to determine precisely the extent to whichthe collateral consists of sovereign debt instruments, one canwager that government bonds represent at least 20%. In2006, the collateral consisted for 21% of government bonds,a proportion that went on to decline to 10% in 2008. Giventhe upturn in sovereign risk, it is likely that the proportion ofgovernment bonds has increased sharply. With the repo ratestanding above the interbank offered rate, banks will tend togive the European Central Bank securities that will not bereadily accepted as collateral in the interbank repo market (in2008, asset-backed securities accounted for much of thesecurities provided as collateral to the European CentralBank).It is in the banks’ interest to offer as collateral the least liquidand lowest rated securities, therefore Greek, Portuguese andSpanish government bonds. More liquid securities can beoffered as collateral easily enough in the interbank repomarket.For the lowest rated securities, i.e. GGBs, the EuropeanCentral Bank has announced that it was accepting allsecurities issued or guaranteed by the Greek State with nominimum rating criterion. It is therefore likely that GGBsretrieved by banks will be offered as collateral to theEuropean Central Bank or sold in the market.The others will be kept because they are can be used morereadily as collateral in the interbank repo market.
ECB – Excess liquidity with continuous adjustment of MROs
MRO + LTRO
Banking system’s theoretical requirementEUR 150bn allotted at 3m LTRO
No allotment at 3m LTRO
EUR 150bn at 3m LTRO + EUR 250bn rolled into MROs