Wednesday, June 26, 2013

Massive decline in euro area's excess reserves is not an indication of improved lending

The decline in euro area banks' excess reserves has been quite spectacular. Excess reserve levels are back to 2011 levels.

Source: ECB
Some are attributing this to banks "no longer hoarding cash" and therefore lending. That's nonsense. This decline in excess reserves was a direct result of banks reducing their borrowing from the Eurosystem. The combination of the MRO, the LTRO, and the MLF loans from the ECB has been falling.

Source: ECB

Why are banks paying off their loans? Some have found alternative sources of funding in the private markets (repo or secured bonds for example), but a great number of Eurozone banks are simply deleveraging. As they reduce their assets, they don't need to borrow as much. Sadly, this deleveraging has resulted in extraordinarily weak loan growth, both to households,

YoY growth in loans to Eurozone households (source: ECB)
... and to corporations.

YoY growth in loans to Eurozone non-financial companies (source: ECB)

While there are some signs of economic improvements in certain parts of the Eurozone, the deleveraging of the banking system and nonexistent loan growth does not bode well for a near-term recovery.
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