We expect banks to continue to partially deplete their still large liquidity reserves to redeem their outstanding LTRO drafts. It is likely that some of the drawings will be refinanced through bond markets to allow for financing with longer maturities.
We believe that banks with a higher LTRO-adjusted LCR ratio would be less likely to refinance their bailout LTROs through other channels, including bond markets. Portuguese, Greek and Finnish banks would likely be among those that could maintain relatively strong LCR levels despite their LTRO liquidations and would therefore see less pressure to refinance their LTROs. According to our analysis, the adjusted LCR in these countries would remain close to or above 160%, leaving a relatively strong cushion above requirements. However, Greek banks would see a substantial negative impact on their LCRs by paying their LTROs with existing liquidity buffers. In these countries, bond supply will likely be driven by other factors, such as bond redemptions, balance sheet developments, and the degree of accumulation of loss-absorbing reserves.
Reducing their LCR ratios to levels seen before the TLTRO-III program would allow many banks to absorb a substantial portion, but not all, of their TLTRO maturities with existing resources. We believe that banks in France, Benelux, Austria and Spain could use a combination of tapping into existing liquidity resources and refinancing part of their LTROs through other sources, including bond markets, for LTRO repayments.
In Italy, existing liquidity resources would be severely affected if LTROs were exhausted without refinancing. Italian LCR levels would fall to levels that are relatively narrow above the minimum requirements and also clearly below levels observed prior to the award of TLTRO-III. Adding the liquidity buffers of less significant institutions would only make a small difference.
Large German banks have not increased their LCR ratios during the TLTRO-III program like banks in other countries. While, in our view, large German banks could absorb the impact of LTROs with their existing reserves, the margin over minimum LCR requirements would be substantially reduced. Including liquidity buffers in Germany’s less significant institutions would change this picture somewhat due to their larger size than in other jurisdictions.
As we think banks would prefer to exhibit stronger liquidity reserves, we would expect the bulk of LTRO repayments to be refinanced in Italy and also, to some extent, in Germany. Therefore, we expect that banks in these countries will be more likely to remain active in bond markets to prepare for the expiration of LTROs.
In addition to printing bonds, banks are likely to use other financing channels, such as repos. In some cases, we may see greater adoption of other central bank funding alternatives, such as shorter LTROs or even OPFs, particularly in an environment of more volatile market conditions. We see the risk of some stigma being attached to the increased withdrawal of funds from the central bank’s shorter operations.
In light of the weak economic environment, reducing borrowing also remains one of the possible alternatives to offset part of the financing needs.
Various ECBs Speakers In recent weeks they have commented on the level of minimum required reserves (MRR). Raising the MRR from the current 1% to a higher level, such as 2%, would depress banks’ LCR Tier 1 liquidity buffers by a similar amount. Combined with the liquidation of LTROs, this would have a substantial impact on banks’ liquidity reserves, and we see a risk of unintended consequences, particularly with a further increase in MRR. We wrote about the possible consequences earlier. here. That said, the ECB is still reviewing its monetary policy operations framework and results are not expected to be presented until spring 2024. Additional, more structural changes are unlikely to occur before then.