Excess euro-area liquidity raises bank lending risks

Significance

The ECB stopped purchasing bonds this month after running its asset purchase programme (APP) since March 2015. The APP flooded commercial banks with liquidity in excess of their minimum reserve requirements, which they could use to grant new loans. The ECB achieved its goal of increasing credit to the private sector, raising domestic demand and warding off price deflation, but commercial banks have kept large amounts of excess liquidity.

Impacts

• Euro-area banks' average profitability has improved during the APP scheme, but less accommodating monetary policy may reverse this trend.
• The high prudential ratios the Basel III regulatory standards require should make euro-area banks more resilient to monetary tightening.
• The ECB's mopping up may pose difficulties to banks relying on excess liquidity to meet the Basel III coverage liquidity ratio.