- THE ECB BLOG
The first year of the Eurosystem’s new operational framework
One year after its announcement, the new operational framework is working as intended. Euro area banks have adapted to declining central bank reserves as the Eurosystem's balance sheet is normalising. The ECB Blog assesses how banks and money markets cope with the new environment.
The normalisation of monetary policy over recent years has also meant declining amounts of central bank reserves in the hands of commercial banks. In March 2024, the Eurosystem announced changes to its operational framework to ensure that it remains appropriate as the central bank balance sheet continues to decline. The new framework foresees that the ECB continues to steer the monetary policy stance through the deposit facility rate (DFR). Moreover, standard refinancing operations (SROs) will play a central role in providing liquidity to banks as needed.[2] Banks can now borrow reserves, i.e. liquidity, through SROs at a rate of 15 basis points above the DFR – compared to 50 basis points previously – with full allotment against a broad set of collateral.
How has central bank liquidity changed?
Excess liquidity has declined by more than €2 trillion from its peak in November 2022. It now stands at €2.8 trillion (Chart 1, panel a).[3] Reserves are still abundant in the banking system overall. Yet, their distribution is uneven. This means that it is important to assess whether reserves are sufficient at the individual bank level.
Banks are adapting to an environment with less ample liquidity in the context of the new operational framework and the fully phased-in liquidity regulation introduced after the global financial crisis.[4] Therefore, it is essential to look beyond banks’ conventional reserve demand as a medium for settling payments and for precautionary purposes; we also need to consider the regulatory value of central bank reserves.
We have conducted a confidential survey of bank treasurers to inquire about the sources of liquidity demand. The survey reveals that a large majority of banks still hold abundant reserves relative to their desired reserve targets. However, 40% of them are already operating close to their internal liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) targets (Chart 1, panel b).[5] Supervisors and banks prioritise managing these ratios via their high-quality liquid assets (HQLA) portfolio and stable term-liquidity funding. This is increasingly shaping money markets.
Chart 1
Liquidity position of euro area banks
a) Path of excess liquidity | b) Share of banks split by liquidity positions |
|---|---|
(EUR billions)  | (percentage)  |
Sources For panel a), ECB calculations. For panel b), ECB (market operations database, Common Reporting Framework/Financial Reporting Framework, Eurosystem survey of bank treasurers), ECB calculations.
Notes For panel a) the Eurosystem excess liquidity projection is based on Survey of Monetary Analysts median expectation of the Eurosystem balance sheet evolution. Panel b) takes bank-level answers to the survey of bank treasurers about their preferred internal targets for reserves, LCR and NSFR, and it compares these against regulatory ratios reported in the third quarter of 2024 and level of reserves held in the fourth quarter of 2024. Where bank answers to the survey are not available, internal targets are extrapolated. Banks are identified as close to LCR/NSFR targets if they hold reported regulatory ratios less than 10 percentage points above the target. Banks are classified as close to reserve targets if their distance to the internal reserve target is in the bottom 25th percentile of the distribution, equivalent to 1.1% of total assets surplus reserves.
Money market rates are well anchored around the policy rate
Central banks like to see that money market interest rates, the rates commercial banks pay to borrow and lend among themselves, align well with monetary policy interest rates. So far, this is the case. As the Eurosystem’s balance sheet normalises, short-term money market rates are well anchored around the DFR. The euro short-term rate (€STR), which is the benchmark rate for unsecured borrowing, has slightly narrowed its spread to the DFR (Chart 2, panel a). And secured money market (repo) rates have gradually moved closer to the DFR.[6]
This development marks a shift from collateral scarcity to collateral abundance owing to the declining Eurosystem balance sheet and rising net government bond issuance.[7] At the same time, the share of repo transactions conducted at rates above the DFR is slowly increasing. It now accounts for about 15% of the traded volume. However, this does not indicate scarcity in reserves, as banks near their reserve target account for only a small fraction of trades above the DFR (Chart 2, panel b – yellow bar). Rather, the higher rates are more likely the result of reserve-rich dealer banks facing increased demand to intermediate government bond transactions from non-banks.
Chart 2
Repo rates anchored at the DFR with no signs of reserve scarcity
a) Short-term rates-DFR spread | b) Share of repo trading above the DFR |
|---|---|
(basis points)  | (percentage)  |
Sources: For panel a) Money Market Statistical Reporting (MMSR) data. For panel b) MMSR data, Securities Financing Transaction Data (SFTD), Bloomberg, ECB calculations.
Notes: Panel a) shows weekly moving averages excluding the month-ends. Repo rate captures MMSR based weighted-average repo rate against government collateral with one day maturity, trimmed. Downward spikes represent prolonged downward pressure owing to collateral scarcity that extended beyond month-ends. Panel b) shows the share of the one-day repo trading volume by rate bucket and which counterparties trade above the DFR. Euro area banks borrowing in repo are classified based on their liquidity positions, foreign banks or entities without access to Eurosystem operations are represented by the grey part in the bar.
Market funding remains attractive to meet liquidity needs
Banks have responded to the decrease in reserves by increasingly managing their liquidity through market activities, with the repo market being the main channel for redistributing reserves.[8] Banks close to their reserve targets borrow in the repo market to keep reserves above their desired levels. However, the portion of repo market activity that is motivated by reserve needs is still limited. Most of the €1 trillion of trading volume comes from banks with reserves well above their internal desired reserve levels.
Borrowing reserves in the market is generally more attractive than using Eurosystem refinancing operations (Chart 3, panel a). Banks can borrow reserves at rates below the DFR in both the repo and the unsecured markets. This explains why their appetite to borrow reserves from the Eurosystem remains low for the time being.
Looking ahead, demand for these operations is expected to increase (Chart 3, panel b). For now, market rates close to the DFR and muted SRO participation indicate that reserves are still ample. Moreover, market funding continues to be comparatively attractive, even after the cost of borrowing from the Eurosystem was reduced to 15 basis points under the new operational framework.
Chart 3
Banks tap markets to satisfy liquidity demand as market funding is economically attractive
a) Relative market pricing of borrowing in money markets vs the expected DFR | b) Use of Eurosystem standard refinancing operations |
|---|---|
(basis points above expected DFR)  | (EUR billions)  |
Sources: For panel a) STEP, Bloomberg, MMSR data, SFTD. For panel b) ECB calculations and Survey of Monetary Analysts (SMA) from March 2025 .
Notes: In panel a) the one-day rates spread to DFR is captured by the yellow dots. The three-month (3M) rates are adjusted for the 3M €STR OIS and the €STR-DFR spread to show the relative yield over the market-implied DFR over the next three months. The “non-HQLA repo” category is based on an estimation which includes all trades with maturity of one to three months similarly corrected for the market implied DFR. The central estimate is captured by a blue -diamond with 90% confidence intervals depicted by the whiskers. Remaining rates show average since 1 Jul 2024- 27 March 2025. For panel b), the projection of the SROs going forward is based on the March 2025 Survey of Monetary Analysts.
Regulatory liquidity demand on the rise
As excess liquidity declines, banks are increasingly focusing on their regulatory liquidity buffers. This has led to increased holdings of government bonds and non-retained covered bonds to offset the reduction in reserves within their HQLA portfolios. To manage their liquidity targets and compensate for TLTRO repayments, banks have also increased their borrowing in term markets. This represents a normalisation in how banks source liquidity and diversify their funding structure.
Chart 4
Banks resort to market funding for HQLA
a) Outstanding term commercial papers | b) Redistribution and generation of HQLA via the term-repo market |
|---|---|
(Index=100 in 2021, first quarter)  | (EUR billions)  |
Sources For panel a), CMD, ECB calculations. For panel b), SFTD, ECB (MOPDB) and ECB calculations.
Notes For panel a) the average outstanding amount of commercial papers (CP) and certificates of deposits (CD) per quarter by euro area domiciled banks in any currency with original maturity above six months. Panel b) shows outstanding volumes of HQLA generated for the borrower, accounting for HQLA-status of the underlying collateral. Open-term repo or evergreen transactions are excluded.
For example, banks have increased their borrowing via term commercial paper by €100 billion, mainly driven by those banks approaching their LCR and NSFR targets (Chart 4, panel a).[9] Term-repos, which boost the LCR, have emerged as a key source that allows banks to generate and redistribute HQLA.[10] In recent years, banks’ borrowing of HQLA through the term repo market has grown tenfold to nearly €350 billion (Chart 4, panel b). This new market segment now accounts for 14% of total outstanding repo transactions. Meanwhile, the prices for term funding have started to rise above those in other money market segments with fewer regulatory benefits. This highlights the importance banks place on market funding with LCR advantages.
Conclusion
One year after its announcement, the new operational framework is working as intended.
Banks have been adapting very well amid an unprecedented decline in excess liquidity. Money market rates are well controlled. And, so far, banks have almost exclusively met their liquidity needs through market sources, rather than by borrowing from the Eurosystem.
Banks use repo markets to redistribute reserves to where they are needed, although their prime focus is on term liquidity to optimise their regulatory liquidity ratios. However, most banks’ desired reserve levels have not yet been tested. As reserves are set to decline further, it will be crucial to ensure that money markets continue to function smoothly and that banks are prepared to use the Eurosystem’s operations in their day-to-day liquidity management.[11]
The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the European Central Bank and the Eurosystem.
We are very grateful to Rita Vitorino Besugo for her contribution to the this article.
See the ECB Blog “Managing liquidity in a changing environment”, by Claudia Buch and Isabel Schnabel.
Excess liquidity is defined as reserves held with the central bank above the minimum reserve requirements. Read the ECB’s explainer on excess liquidity for more detail.
In January 2018 the LCR was fully phased in. The NSFR has been applicable in the EU at a minimum of 100% since 28 June 2021. The regulation puts emphasis on the stability of term funding sources. For compliance with the LCR, banks are encouraged to secure funding beyond one month maturity, and for the NSFR the funding should be above 12 months (or six months counting at 50% discount).
Banks’ preference to hold reserves beyond minimum required reserves relates to settlement needs including intraday liquidity, the wish to signal a strong liquidity position to investors, prudent internal liquidity management rules to account for sudden market volatility or margin calls, and based on supervisory guidance. Banks also set internal targets for the LCR and the NSFR above the 100% minimum regulatory requirement for prudential reasons for example in the internal liquidity adequacy assessment process. The targets represent a reference point for banks’ internal liquidity risk management processes.
Repo refers to repurchase transactions, a type of short-term loan where one party sells a financial asset with a simultaneous commitment to repurchase that asset at a future date. The repo market is therefore also called the secured money market, as borrowing of liquidity (reserves) is secured by collateral (typically government bonds) which the cash lender keeps as insurance should the borrower not repay the loan. Before the global financial crisis, reserves were mainly redistributed via unsecured borrowing and bank lending.
Please also see Isabel Schnabel’s speech on the ECB’s balance sheet reduction.
Please see The ECB Blog 'Repo markets: Understanding the effects of a declining Eurosystem market footprint' for more detail. Before the global financial crisis, reserves were mainly redistributed via unsecured overnight deposits. Currently, the unsecured overnight deposits market is mostly channelling deposits of non-banks to banks that can, in turn, place the liquidity with the central bank as reserves. See the ECB’s webpage on the €STR for more details. In addition, see Isabel Schnabel’s speech on the ECB’s balance sheet reduction.
See The ECB Blog 'how banks deal with declining excess liquidity'.
The LCR ensures that banks have an adequate stock of unencumbered HQLA that can be converted easily and immediately in private markets into reserves to meet their liquidity needs for a 30-calendar day liquidity stress scenario. Borrowing in the term (maturities above 30 days) repo market secured by non-HQLA collateral has a positive impact on banks’ reported LCRs. In these term-repo transactions, the borrowing bank increases the HQLA numerator as it exchanges non-HQLA collateral for HQLA reserves, while the outflow denominator only starts to be affected as the maturity of the repo falls below 30 days. For maturities that are longer than six months, the transaction would additionally carry NSFR benefits.
See The ECB Blog 'Managing liquidity in a changing environment', by Claudia Buch and Isabel Schnabel.