The euro area's interbank markets: searching for normality via unusual channels

The interbank market plays a fundamental role in a country or region's economy as a whole, particularly if its banking system is highly developed, as in the case of the euro area. First of all, it is the first step in the mechanism for monetary policy transmission so the conditions under which it operates (for example, its prevailing interest rates) largely determine the financing conditions for households and companies, with direct implications for the real economy. It is therefore a huge problem if the interbank market does not work properly, as happened repeatedly between 2007 and 2011. The emergency actions taken by the central banks of almost all developed countries were decisive in cutting short those liquidity crises. Fortunately, the workings of the wholesale bank funding markets have gradually improved since then but there still seems to be too much geographical fragmentation in the euro area's interbank market, both in the secured segment (namely repo operations where the borrower provides assets
as a guarantee) and unsecured (where there are no such guarantees). One of the remedies being tried by the ECB, namely establishing a negative «return» for its deposit facility (hereafter DF), has been widely questioned regarding its efficacy and possible side effects.

For several months now banks have had to pay for the amounts they deposit with the ECB's DF (and, logically, for any current account that exceeds the minimum requirement established by the reserve coefficient). In June the penalty was set at 0.10%, increasing to 0.20% as from September. It is obvious that, with this unusual decision, the monetary authority has reinforced the downward trend in Euribor rates, undoubtedly one of its intentions. However, a complete assessment of this measure's repercussions must take other aspects into account, aspects which are being extensively discussed. The relevant question is whether, as argued by those defending the measure, it will make interbank market operations more fluid, boost credit and ease financial conditions for households and companies, particularly those in the peripheral countries. Those against this measure, however, warn that the effects could be the opposite. Firstly because negative interest rates might encourage those banks with surplus liquidity to reduce this, instead of offering it on the interbank market. Such possible reticence in supply could lead to those banks that normally request funds to look for ways to reduce their dependence on the interbank market, such as decreasing their asset operations. In other words, it is argued that this decision might ultimately be detrimental to boosting credit in the real economy. Although it is still too early to draw any definitive conclusions, the initial evidence seems to give the benefit of the doubt to the ECB. Volumes in the EONIA market (overnight interbank rates) have remained notably stable over the last few months and have even posted slight increases. Banks' excess liquidity has not changed substantially in this period either. With a view to the coming quarters, the EONIA rate is more than likely to stabilise at negative levels, very close to the deposit facility rate. In fact, the probable increase in excess liquidity in the euro area, resulting from the start-up of the TLTROs and private bond purchases by the ECB, should bolster this situation. However, such encouraging signs must not make us forget the significant degree of fragmentation that still remains, a phenomenon that bond and money market operators from financial institutions in the periphery of Europe are still concerned about. The ECB's measures are clearly a help but not a cure-all. The stress and solvency tests on European banks, as part of the future banking union, and the reforms being carried out by governments constitute the basic pillars for the complete restoration of normal operations to interbank markets. This last point is crucial to reduce the perception of counterparty risk that still prevails in the financial institutions of those countries carrying out adjustments and, in turn, such a reduction is essential for easier monetary conditions to be passed on, finally and completely, to companies and individuals.