Eurozone banks’ TLTRO repayments are below market expectations

Banks in the eurozone will repay over €296 billion ($306 billion) in cheap loans to the European Central Bank on November 23.

The ECB announced the figure today (November 18). The first tranche of repayments are about 14% of the total outstanding amount of Targeted Longer-Term Refinancing Operations (TLTRO) loans.

Nonetheless, these repayments are below most market expectations. For instance, a Bloomberg survey of economists released earlier this week forecast repayments would range from €200 billion to €1.5 trillion this month. The median estimate was €600 billion.

The ECB offered banks TLTRO loans during the Covid-19 pandemic to keep credit available for households and companies. According to ECB data, overall lending to banks related to monetary policy purposes amounted to over €2.12 trillion on November 11, almost all in TLTROs.

Relatively low repayments could spell trouble for two key policy goals the ECB aims to achieve with these early repayments. The first objective is reducing the central bank’s balance sheet to continue monetary policy normalisation and tackle very high inflation.

The ECB’s governing council has increased interest rates by 200 basis points since July and removing liquidity from the system helps reinforce that strategy.

“These sizeable early repayments reduce the Eurosystem balance sheet and thereby contribute to the overall normalisation of monetary policy, which is needed to bring inflation back to target over the medium term,” said ECB executive board member Isabel Schnabel on Twitter.

The second aim is to boost collateral in the eurozone repo market, which lacks high-quality securities, partly due to the ECB’s expanded balance sheet. This has contributed to put downward pressure on money market rates over the last months.

New repayment opportunities

The governing council modified conditions of the third TLTRO programme at its latest monetary policy decision on October 27. It decided to remove the favourable financing conditions banks enjoyed holding these funds, drastically increasing the interest rates on them.

The third TLTRO programme includes 10 targeted longer-term refinancing operations, each with a three-year maturity. The first took place in September 2019, and the others followed on a quarterly basis.

Originally, banks’ borrowing rates in these operations could be as low as 50bp below the average interest rate on the deposit facility over the period from June 24, 2020 to June 23, 2022. Since the deposit rate stood at -0.5% since September 2019 until July 2022, this meant rates could be as low as -1%.

In October, the ECB decided that rates on all remaining TLTRO III operations will be indexed to its ECB policy rate from November 23. The ECB deposit rate is now at 1.5%, and the governing council is widely expected to take it over 2% over the coming meetings.

In order to offer banks the option of not facing much higher rates on these holdings, the ECB added three voluntary early repayment dates. This could be of the total outstanding value of their TLTRO holdings or part of them.

The ECB required lenders to inform their respective national central banks by November 16, 2022 if they wanted to use the first window. The next repayment window will open in December.

Banks’ incentives to repay

“From November 23, the TLTRO cost will realign with the remuneration of deposits at the ECB,” says Camille de Courcel, head of European rate strategies at French bank BNP Paribas. While seemingly neutral, banks will weigh the regulatory cost of holding onto their “TLTROs versus the now flat carry”.

One regulatory effect is how TLTROs funds allow banks to include them in their Net Stable Funding Ratio (NSFR) at year-end reporting. However, this is about to change, as banks can use ECB loans to meet capital requirements as long as their maturity is over 6 months.

However, €1.35 trillion of TLTROs expire by June 2023. “These TLTROs are therefore deemed to be no longer NSFR-efficient, which could be a reason to repay,” says de Courcel.

But the ECB also ruled that bank loans made in the pandemic to households and non-financial firms would be eligible as collateral until March 2024. This makes these loans an indirect source for banks to cover their Liquidity Coverage Ratios because they offer them access to TLTROs.

“Banks can transform those non-high-quality liquid assets into high-quality liquid assets with the TLTRO money, which could be a reason to hold onto the money,” says de Courcel.

Overall, she estimates more than €600 billion in repayments are still possible before the end of the year. “As the residual maturity of TLTRO operations fall below six months, making it ineligible for NSFR calculation, early repayments tend to accelerate,” she says.

She points out banks in peripheral eurozone economies are more inclined to repay, mainly to avoid higher interest rates on TLTROs.

“In Spain alone, the feedback reportedly suggests close to €200 billion repayments by year end,” de Courcel adds. As a result, she says: “We could see around €650 billion of repayments covering November and December.”