Talk that banks are already looking at how they will repay cash taken from the European Central Bank under its longer term refinancing operation should come as no surprise. It would be simply irresponsible to take the cash, lend it on, and have no idea how to free it up to pay it back in three years’ time.
Similarly, it should be expected that some banks will pay back some of their borrowings when they have the first opportunity to do so, one year after first drawing down the funds. The money is cheap, but it is not free: banks must pledge collateral against the borrowing, as well as paying a 1% fee. If they are just parking the cash at the ECB, it is possible that by the end of the year, the negatives of that cost of carry will outweigh the benefits of having emergency liquidity to hand.
The balance of utility was skewed the other way when the LTRO was conceived. Given the dire state of the wholesale markets at the end of 2011, banks would have been foolish not to take the funding.
Banks that reduce their LTRO borrowings on the first anniversary will demonstrate a commitment to return to a sustainable funding model, and a renewed desire to escape the crisis. But it would not be in anyone’s interest for such moves to create a stigma towards those that hold on to the funding.
Arguably, the LTRO was the main reason the lights switched on over the European bond market in January, after a very dark second half. Investors knew banks were more liquid, and that made everyone more comfortable. To suck all that extra liquidity out of the system now by encouraging banks to exit the LTRO early would be to risk losing that comfort — and to risk switching the lights back off.
Banks that are confident they can pay back the LTRO money early should be commended. But not at the expense of those who believe it prudent to hold on to the cash a little longer.