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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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Kostas Kalevras

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