Are Eurozone banks ‘hoarding’ liquidity?

10th January 2012

An increase in the ECB's lending to banks in repo operations automatically injects liquidity into the system. Banks hold this cash either in their current accounts at the ECB or the deposit facility. Since they earn no interest on current account balances in excess of reserve requirements, it mostly ends up in the deposit facility.

Suppose that banks holding more cash than they desire increase lending or buy existing securities (i.e. they don't "hoard"). The cash is transferred to other banks (those where the recipients of the lent funds or the sellers of the securities hold their accounts), whose current account / deposit facility balances therefore rise. The aggregate position only falls if some of the cash ends up with weaker banks, who then repay their loans from the ECB, thereby withdrawing liquidity from the system. Otherwise, use of the deposit facility will remain high even though banks are not "hoarding". (Liquidity can also be withdrawn by banks buying new government securities, resulting in cash being transferred from banks' to governments' accounts with the ECB.)

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