Banks would likely look to take steps to offset some of the impact on profitability and liquidity metrics following an increase in MRR.
One way would be to try to limit the size of the increase. The MRR is calculated based on customer deposits and financing of less than two years. Banks could try to replace their short-term financing with longer-term financing. They could also try to rebalance their funding profile, away from deposits and towards bond markets. This would limit the increase in deposit rates, while the higher proportion of wholesale financing would have a negative impact on net interest income. However, not all banks can issue long-term financing at sustainable levels. Even the highest-rated banks appear to have recently avoided printing at the longer end of the bank bond curve, as investor demand appears to be present primarily at the shorter end and perhaps at the bottom of the curve due to Current interest rate expectations and the shape of the curve.
The potential negative impact on liquidity reserves is large and would occur in an environment with recent bank failures in both the United States and Switzerland, all driven in one way or another by a sudden loss of liquidity. We consider a decline in liquidity buffers as a risk factor, particularly in the context of the current decline of the TLTRO-III financing program, which is scheduled to fully mature in 2024.
Some very liquid banks could absorb the loss of their LCR ratios with existing buffers. Others would probably try to replenish the levels. In addition to reducing the MRR, alternatives here would include cutting borrowing or perhaps increasing wholesale financing to replenish liquidity reserves.
The banks most affected by the change would be those with lower credit ratings, as they would have to pay more in the form of higher risk premiums for their bond market financing. In the end, more banks could end up using the ECB’s normal refinancing operations which, in the past, have been associated with a negative stigma and only offer short-term relief due to the relatively short maturity of three months in the case of LTROs. . .
An increase in minimum required reserves would be clearly negative for banks. While the excess liquidity of €3.66 trillion still floating in the system would limit the impact to some extent, in combination with the expected exit from the TLTROs, we believe there could be a risk of unintended consequences.
If the ECB wanted to limit the likely impact on bank liquidity, it could consider adjusting the LCR calculation in relation to minimum reserves.