Excess liquidity and bank lending risks in the euro area

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Excess liquidity and bank lending risks in the euro area

In this Policy Contribution prepared for the European Parliament’s Committee on Economic and Monetary Affairs (ECON) as an input to the Monetary Dialo

Publishing date: 26 September 2018
Authors: Zsolt Darvas David Pichler

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This Policy Contribution was prepared for the European Parliament’s Committee on Economic and Monetary Affairs (ECON) as an input to the between ECON and the President of the European Central Bank. Copyright remains with the European Parliament at all times.

Excess liquidity (defined as all kinds of commercial bank deposits held by the Eurosystem minus the minimum reserve requirements) in the euro area exceeded €1,900 billion, or 17 percent of euro-area GDP, in September 2018. Holding such excess liquidity is costly for commercial banks, given that the currently negative (-0.4 percent) deposit facility interest rate applies on excess liquidity holdings. The current stock of excess liquidity implies an annual €7.6 billion cost in total for those banks that hold this liquidity. More generally, the European Central Bank’s negative deposit interest rate and asset purchases further reduced market interest rates, with a negative impact on banks’ net interest income and thus profitability. This could incentivise a reach-for-yield race among banks. Additionally, the access to liquidity eased significantly and removed the liquidity constraint for most banks’ lending activities. These factors might incentivise banks to engage in risky lending in order to improve their profits. This in turn might create financial stability risks.

The authors clarify the definition of excess liquidity, to highlight the reasons why such a large amount of it is being held, and to assess its financial stability implications.

About the authors

Zsolt Darvas

Zsolt Darvas is a Senior Fellow at Bruegel and a part-time Senior Research Fellow at the Corvinus University of Budapest. He joined Bruegel in 2008 as a Visiting Fellow, and became a Research Fellow in 2009 and a Senior Fellow in 2013.

From 2005 to 2008, he was the Research Advisor of the Argenta Financial Research Group in Budapest. Before that, he worked at the research unit of the Central Bank of Hungary (1994-2005) where he served as Deputy Head.

Zsolt holds a Ph.D. in Economics from Corvinus University of Budapest where he teaches courses in Econometrics but also at other institutions since 1994. His research interests include macroeconomics, international economics, central banking and time series analysis.
David Pichler

David was a research assistant at Bruegel focusing on macroeconomic related topics, fiscal and monetary policy. Before joining Bruegel, David worked as a trainee at the European Central Bank as well as at the European Investment Bank. He obtained a Master’s degree in Economics from Warwick University after completing his undergraduate programme in Economics at University of Graz, Austria.

David has been working for the Austrian NGO Childrenplanet which supports projects in education, clean drinking water provision and health care in Cambodia. He is a native German speaker, fluent in English and has good knowledge in Spanish.