01 February 2019

ECB occasional paper: Availability of high-quality liquid assets and monetary policy operations: an analysis for the euro area

This paper provides an overview of supply and demand factors influencing the availability of euro-denominated debt instruments that qualify as high-quality liquid assets (HQLA) in the euro area. The paper estimates the supply of HQLA issued by the public and private sectors as well as the aggregated impact of Eurosystem monetary policy operations on the amount and composition of HQLA held by banks and other economic agents.

Regulatory reforms implemented in the wake of the financial crisis and structurally higher risk aversion are commonly cited as factors that can boost demand for secure and liquid assets among economic agents. Instruments with these features that are suitable for the euro area are defined in Delegated Regulation (EU) 2015/61, which classifies so-called HQLA in terms of the liquidity coverage ratio (LCR) requirement for banks. This paper aims to quantify the supply of HQLA in the euro area and to analyse the most relevant factors affecting their availability (i.e. amount and composition) to banks and other economic agents, so as to assess whether scarcity of HQLA is an issue in the euro area.

The paper shows that there is a large supply of HQLA, since public and private entities incorporated in the EU issue marketable euro-denominated debt instruments qualifying as HQLA in considerable quantities (€10.9 trillion as of Q3 2017), mostly in the form of government (89%) and covered bonds (6%). This supply has been relatively stable over time and is substantial compared with euro area GDP. This confirms the assessment of the European Banking Authority (EBA) that HQLA are, on an aggregated level, not scarce in the euro area.

In the current environment, euro area banks hold EUR 3.8 trillion of euro-denominated HQLA, of which 47% consist of excess reserves (i.e. reserves supplied by the Eurosystem in excess of the euro area banking system reserve requirements) and the remaining 53% of marketable assets, mainly government bonds. The aggregate HQLA holdings of the euro area banking system correspond to an aggregated LCR of just under 150% as of Q3 2017, versus a required minimum of 100% as of 1 January 2018. Pension funds and insurance companies (€2.1 trillion), investment firms, non-financial corporations and similar economic agents (€1.4 trillion) and non-euro area entities including foreign central banks (€2.6 trillion) also hold considerable quantities of HQLA.

Aside from the LCR requirement, demand for HQLA can also be driven by other factors such as the European Market Infrastructure Regulation (EMIR) for the OTC derivatives market and the increased preference for secured money market transactions. The maximum demand due to the EMIR is estimated to be €0.7 trillion for the euro area financial system. An assessment of the relationship between repo market activity and HQLA availability highlights that:

• a sufficient level of marketable HQLA outstanding should be available for the repo market to function properly;
• if the role of margins and haircuts is neglected, secured transactions mainly redistribute securities and cash among different economic agents, although repo transactions between banks and non-banks affect the amount of HQLA available to the banking sector.

The amount and type of HQLA available to banks and other economic agents also depend on central banks’ balance sheet developments, i.e. on HQLA held, encumbered or provided via central bank operations through both the asset and liability side of the balance sheet. Specifically, the Eurosystem has absorbed around €2.6 trillion of HQLA through outright portfolios and refinancing operations. The amount of HQLA provided stands at €1.8 trillion of excess reserves and €1.1 trillion of banknotes. Moreover, Eurosystem securities lending operations, non-monetary policy deposits and other liquidity-absorbing instruments can potentially affect the amount and type of HQLA available in the market.

An environment with less sizeable excess reserves implies that either less marketable HQLA are absorbed via monetary policy operations, making these assets again available to the market, or liquidity in excess of the banking system’s needs is absorbed via other central bank liabilities. This could in theory mean that HQLA are provided in the form of debt certificates, term deposits or reverse repos, for instance. Consequently, the overall stock of HQLA would not necessarily decrease substantially. In such an environment, however, banks, which currently hold considerable amounts of excess reserves, might need to substitute excess reserves with marketable HQLA in order to maintain their current LCR buffers. If there is a safe asset premium for the preferred marketable HQLA (e.g. highly rated government bonds), banks might need to pay a higher price compared with the current situation to hold a liquidity buffer of the same size. Consequently, the level of excess reserves could have an impact on the relative cost of holding a liquidity buffer for banks

Occasional paper

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