The first year of the Eurosystem’s new operational framework

25 April 2025

By Benjamin Hartung, Tobias Linzert, Imène Rahmouni-Rousseau, Yannik Schneider and Marta Skrzypińska^[1]

The normalisation of monetary policy over recent years has also meant declining amounts of central bank reserves in the hands of commercial banks. In March 2024, the Eurosystem announced changes to its operational framework to ensure that it remains appropriate as the central bank balance sheet continues to decline. The new framework foresees that the ECB continues to steer the monetary policy stance through the deposit facility rate (DFR). Moreover, standard refinancing operations (SROs) will play a central role in providing liquidity to banks as needed.^[2] Banks can now borrow reserves, i.e. liquidity, through SROs at a rate of 15 basis points above the DFR – compared to 50 basis points previously – with full allotment against a broad set of collateral.

How has central bank liquidity changed?

Excess liquidity has declined by more than €2 trillion from its peak in November 2022. It now stands at €2.8 trillion (Chart 1, panel a).^[3] Reserves are still abundant in the banking system overall. Yet, their distribution is uneven. This means that it is important to assess whether reserves are sufficient at the individual bank level.

Banks are adapting to an environment with less ample liquidity in the context of the new operational framework and the fully phased-in liquidity regulation introduced after the global financial crisis.^[4] Therefore, it is essential to look beyond banks’ conventional reserve demand as a medium for settling payments and for precautionary purposes; we also need to consider the regulatory value of central bank reserves.

We have conducted a confidential survey of bank treasurers to inquire about the sources of liquidity demand. The survey reveals that a large majority of banks still hold abundant reserves relative to their desired reserve targets. However, 40% of them are already operating close to their internal liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) targets (Chart 1, panel b).^[5] Supervisors and banks prioritise managing these ratios via their high-quality liquid assets (HQLA) portfolio and stable term-liquidity funding. This is increasingly shaping money markets.

Money market rates are well anchored around the policy rate

Central banks like to see that money market interest rates, the rates commercial banks pay to borrow and lend among themselves, align well with monetary policy interest rates. So far, this is the case. As the Eurosystem’s balance sheet normalises, short-term money market rates are well anchored around the DFR. The euro short-term rate (€STR), which is the benchmark rate for unsecured borrowing, has slightly narrowed its spread to the DFR (Chart 2, panel a). And secured money market (repo) rates have gradually moved closer to the DFR.^[6]

This development marks a shift from collateral scarcity to collateral abundance owing to the declining Eurosystem balance sheet and rising net government bond issuance.^[7] At the same time, the share of repo transactions conducted at rates above the DFR is slowly increasing. It now accounts for about 15% of the traded volume. However, this does not indicate scarcity in reserves, as banks near their reserve target account for only a small fraction of trades above the DFR (Chart 2, panel b – yellow bar). Rather, the higher rates are more likely the result of reserve-rich dealer banks facing increased demand for intermediate government bond transactions from non-banks.

Market funding remains attractive to meet liquidity needs

Banks have responded to the decrease in reserves by increasingly managing their liquidity through market activities, with the repo market being the main channel for redistributing reserves.^[8] Banks close to their reserve targets borrow in the repo market to keep reserves above their desired levels. However, the portion of repo market activity that is motivated by reserve needs is still limited. Most of the €1 trillion of trading volume comes from banks with reserves well above their internal desired reserve levels.

Borrowing reserves in the market is generally more attractive than using Eurosystem refinancing operations (Chart 3, panel a). Banks can borrow reserves at rates below the DFR in both the repo and the unsecured markets. This explains why their appetite to borrow reserves from the Eurosystem remains low for the time being.

Looking ahead, demand for these operations is expected to increase (Chart 3, panel b). For now, market rates close to the DFR and muted SRO participation indicate that reserves are still ample. Moreover, market funding continues to be comparatively attractive, even after the cost of borrowing from the Eurosystem was reduced to 15 basis points under the new operational framework.

Regulatory liquidity demand on the rise

As excess liquidity declines, banks are increasingly focusing on their regulatory liquidity buffers. This has led to increased holdings of government bonds and non-retained covered bonds to offset the reduction in reserves within their HQLA portfolios. To manage their liquidity targets and compensate for TLTRO repayments, banks have also increased their borrowing in term markets. This represents a normalisation in how banks source liquidity and diversify their funding structure.

For example, banks have increased their borrowing via term commercial paper by €100 billion, mainly driven by those banks approaching their LCR and NSFR targets (Chart 4, panel a).^[9] Term-repos, which boost the LCR, have emerged as a key source that allows banks to generate and redistribute HQLA.^[10] In recent years, banks’ borrowing of HQLA through the term repo market has grown tenfold to nearly €350 billion (Chart 4, panel b). This new market segment now accounts for 14% of total outstanding repo transactions. Meanwhile, the prices for term funding have started to rise above those in other money market segments with fewer regulatory benefits. This highlights the importance banks place on market funding with LCR advantages.

Conclusion

One year after its announcement, the new operational framework is working as intended.

Banks have been adapting very well amid an unprecedented decline in excess liquidity. Money market rates are well controlled. And, so far, banks have almost exclusively met their liquidity needs through market sources, rather than by borrowing from the Eurosystem.

Banks use repo markets to redistribute reserves to where they are needed, although their prime focus is on term liquidity to optimise their regulatory liquidity ratios. However, most banks’ desired reserve levels have not yet been tested. As reserves are set to decline further, it will be crucial to ensure that money markets continue to function smoothly and that banks are prepared to use the Eurosystem’s operations in their day-to-day liquidity management.^[11]

The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the European Central Bank and the Eurosystem.