EUR excess liquidity – ECB to speed up liquidity tightening next year

Euro area excess liquidity is coming into focus again, complementing the ECB’s monetary policy tightening via rates. Earlier this week, Reuters reported that the ECB wants to start discussing how to lower excess liquidity, according to six people familiar with the matter. The Bundesbank’s Nagel said earlier today that it may raise the minimum reserve requirement remuneration again next year.

Specifically, the article also reported that the ECB could increase the minimum reserve requirements, which we estimate would bring excess liquidity lower by EUR350-500bn and impact the liquidity coverage ratios of the euro area banks by 13pp (median estimate).

This piece serves as a primer on excess liquidity and the minimum reserve requirement, where we also highlight the current drivers for excess liquidity and we examine the outlook for euro excess liquidity.

We construct four scenarios for the potential evolution of excess liquidity. In our baseline, most aggressive balance sheet tightening calibration, we could see upside risk to short-end fixings from late 2025, at the earliest, assuming that the structural demand for liquidity has moved the sensitivity ‘kink’ on the excess liquidity vs. front end fixings to around EUR1.5.

Setting the scene - The definition of excess liquidity

According to the ECB, excess liquidity is defined as the sum of recourse to the deposit facility (DF) minus marginal lending facility (MLF) plus current account holding (CA) minus the minimum reserve requirements (MRR), i.e.

excess liquidity = (DF – MLF) + (CA-MRR).

In recent years, the key drivers of excess liquidity have been the deposit facility and current account, as the abundant excess liquidity has resulted in almost no recourse to the MLF. The MRR has been rising steadily, following the demand for deposits. With the comments from ECB sources this week, focus turns to what the ECB may do about the MRR to drain liquidity from the system. Note that euro area banks have placed EUR3.62bn at the deposit facility at a rate of 4% while banks are not using the MLF, which carries a rate of 4.75%.

The minimum reserve requirement is set as a fixed percentage of a specific set of each bank’s liabilities, which are mainly customer deposits. Currently, each euro area bank needs to hold 1% of those liabilities on average over the maintenance period, which is a 6-8 week window that follows between each ECB rate decision meeting. 1% of those liabilities currently correspond to EUR165bn. The MRR was lowered from 2% to 1% in 2012. Note that the cut-off used for the September 2023 maintenance period, which started yesterday, was at the end of July 2023. The specific liabilities are defined as ‘Overnight deposits, deposits with agreed maturity or period of notice up to 2 years, debt securities issued with maturity up to 2 years, money market paper‘.

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