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Since it’s been a few months since I took a look at periphery NCB balance sheets, it’s time to examine trends during 2013.
Spain
Spain seems to be the one driving overall Open Market Operations (OMOs) usage down:
Since December, OMOs have declined from €357.29bn to €270.94bn (-€86.35bn) with 80% attributed to a fall in LTRO usage. It seems that Spanish banks are confident to repay a significant part of their LTRO borrowing from the ECB which, given the low interest rates of LTRO funding and the relaxed collateral rules, imply that market conditions have improved strongly. During the same period, the consolidated Eurosystem OMO funding to European banks has dropped €225bn which means that Spanish banks account for almost 40% of the relevant fall (with another large part accounted by French and German banks).
Looking into the balance sheet at more detail, one observes that use of the deposit facility was €44.2bn in December and only €10.94bn during March, reflecting much lower safety buffers for Spanish banks. This is linked to the drop in Target2 liabilities, from €352,4bn in December to €298.3bn in March (-€54.1bn). Still, liabilities continue to be high, almost 28% of Spanish GDP although they are much lower than their maximum of €428.6bn in August 2012 (a fall of €130.3bn).
The drop in Target2 liabilities is related to the increase in non-residents government debt securities holdings, with registered holdings increasing €30bn since October, from €209.6bn to €240.4bn in February (an almost 15% increase).
Overall, credit conditions have clearly eased during the last few months. Nevertheless, both the situation in the real economy and current NPL figures point to large risks ahead for the Spanish banking system. Spanish banks will probably keep low quality collateral (such as credit claims) parked at the ECB and only use high quality securities in order to borrow in the repo market at low interest rates (since current repo rates are close to 0.02-0.03%).
Italy
The Italian case seems to be a bit more muted than Spain. Since December, bank borrowing from the central bank of Italy has dropped only marginally from €271.8bn to €268.2bn with a somewhat larger fall in LTRO usage from €268.3bn to €262bn. This is mainly explained from the fact that Target liabilities only dropped from €255.1bn to €242.9bn. It seems that Italy has decoupled from Spain, probably due to the results of the recent national elections and the inability to form a stable government as well as the fact that government debt figures are moving close to the 130% GDP figure.
This is also reflected on the general government debt statistics which illustrate the fact that non-residents holdings of securities have been extremely steady during the last few months and are much lower than 2011 figures.
Following the release of Bank of Italy balance sheet for March, Bank of Spain released the same data today. In this case, the main points to be made are:
- Banks increased their net lending from the Eurosystem by EU146.5bn to EU316.3bn. The increase came from new LTRO lending of EU163bn and a drop in MRO lending to the (negligible) amount of EU1.0bn (down from EU17.5bn) making all lending long-term. Total central bank credit of EU316bn is now a substantial percent of the Spanish banks holdings of securities (EU620bn in February), even if Bank of Spain accepts collateral at par (which it does not). More than 50% of bank securities holdings are now parked in ECB although a substantial amount of collateral pledged probably is performing credit claims.
- Net liabilities to the Eurosystem increased by EU55.2bn to EU252.1bn. In total, Spain and Italy now account for more than EU520bn in Target2 liabilities (an amount equal to net liquidity created by the two LTROs).
- The deposit facility increased to EU88.7bn marking a healthy liquidity position (although with a substantial cost due to net lending (in contrast with German banks which increase their deposit facility holdings due to increased net claims to Target2).
The difference with Italian banks which used the LTROs only to finance their negative position with Target2 is significant. Spanish banks keep a large buffer of almost EU90bn in their bank reserve accounts which can cover carry trades and increased Target2 needs for the next months. The troubling fact is that probably most of their tradable assets are now posted long term on Bank of Spain balance sheet (which is a senior creditor) making it hard to find finance in the secured and unsecured money markets. The fact that Spanish banks hold such large amounts on excess liquidity makes the recent increase in Spanish sovereign debt yields rather strange, since that should provide an opportunity for an easy carry trade.
On a related note, Bundesbank also released its Target2 claims for March, which increased by EU68.6bn to EU615.6bn. This is clearly an unsustainable path, especially since on November (before the 3-year LTROs), Target2 claims were EU495.2bn, an increase of more than EU120bn. Almost 25% of the LTROs was used to finance transfers to the German bank system in just 4 months time. The latter should now probably be in a position to basically not need financing from the Bundesbank which might be obliged to provide liquidity absorbing facilities (term deposits, debt certificates) soon. Otherwise, short-term money market rates in Germany will fall to the deposit facility rate, marking significant monetary easing for the Euro core.
Such capital movements (and differences in lending costs and collateral value) make it quite clear that the Eurosystem will face a very stressed situation in the coming months. ECB action will be needed, either in the form of another LTRO or sovereign bond buying (which since the Greek PSI rather complicates than helps the situation).
If one were to extrapolate based on Germany’s Target2 claims data for 2011 and 2012, the best fit would be a polynomial curve pointing to a surplus of over €1tr at the end of 2012. Obviously such trends are clearly unsustainable:
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