Euro zone banks return nearly $308 billion in cheap ECB funding

Euro zone banks are set to repay nearly $310 billion in loans to the European Central Bank next week, the ECB said on Friday, the biggest cash withdrawal from the euro zone’s financial system in the euro's 22-year history.

The move is part of ECB efforts to fight record-high inflation in the euro zone by raising the cost of credit and it is its first step towards mopping up even more liquidity next year by trimming its multi-trillion-euro bond portfolio.

The euro zone’s central bank said lenders would repay 296 billion euros worth of the 2.1-trillion-euros, multi-year credit they have taken under its Targeted Longer-Term Refinancing Operations (TLTRO) when they get their first chance to do so on November 23.

This is less than the half a trillion euros that analysts were expecting but still the biggest drop in excess liquidity since records began in 2000.

The one-week ESTR rate, which measures borrowing costs for banks after the repayment goes through, fell after the ECB’s announcement, as did yields on Italy’s two-year government bonds.

ECB policymakers will look at how the market digests this sudden drop in cash to gauge how fast they can proceed with reversing the ECB’s $3.3-trillion Asset Purchase Programme, which they will discuss at their December 15 meeting.

This is the first voluntary repayment window so analysts had cautioned that some bank treasurers may choose to wait until the next one on December 21 to have better visibility on the state of their balance sheet before year-end results.

While this early TLTRO reimbursement is voluntary, the ECB has given banks an incentive to get rid of those loans by taking away a rate subsidy last month.

The greatest impact from the repayments was likely to be seen in peripheral countries, which would see a bigger proportion of their government bonds come back on the market after being locked at the ECB as collateral for the TLTRO loans.

The other area of focus for the ECB is money markets, in which banks lend to each other for a short time.

Those markets have been hampered by the ECB’s policy for years as banks could not find high-quality bonds to use as collateral for borrowing or did not have an incentive to do so when they could simply tap TLTRO for subsidised loans.

Antoine Bouvet, a strategist at ING, said the lower-than-expected repayment “deals a blow to hope of near term” relief in collateral scarcity.

Curbing The Excess

• Banks seen repaying about $517 bn in TLTRO loans
• Move seen as first step towards bond unwind
• Move is part of the ECB efforts to fight record-high inflation