Eurozone banks have deposited €1.9tr in cash at the ECB, but under the tiered deposit rate scheme up to six times of each bank’s minimum reserve requirement (MRR) — approximately €800bn — will now return 0% rather than minus 0.5%.
With about 90% of the covered bond market negative yielding, it seems fair to assume that the ECB’s tiering facility offers a better choice of investment. Yet, so far, the impact on covered bond spreads has been negligible.
After the first wave of selling that followed the ECB’s less-than-expected 10bp cut in the deposit rate to minus 0.5% in September, secondary market flows have been balanced, and have not skewed towards selling.
Two undersubscribed covered bonds that were issued last week by Deutsche Pfandbriefbank and Hypo Tyrol left some thinking the effect of the ECB’s policy was starting to show.
But that view was disputed as investors, who have had a surfeit of deals to choose from earlier this year, became pickier and are now passing on bonds from smaller issuers.
The most likely explanation for the resilience of covered bond spreads is that the deposit tiering facility does not affect the banks that bought covered bonds.
It would only make sense to sell negative yielding covered bonds and place cash at 0% with the ECB if a bank’s deposits at the central bank were below six times its MRR.
Banks with excess cash above six times their MMR still need to invest that money somewhere, and since covered bonds pay more than minus 0.5%, they may as well stay invested in them.
According to analysis undertaken by Crédit Agricole, Portuguese, Italian and Greek banks’ reserves are below six times their MMR, but all the other European banks have higher reserves.
Indeed, in core Europe, banks are drowning in liquidity. German and Dutch banks run average excess liquidity of almost 17 times their MRR, French banks’ excess liquidity is 19 times their MRR, and Finnish banks have a multiple in excess of 38 times, according to Crédit Agricole.
Banks on the margins of the six times MMR threshold, such as those in Spain where the average is 6.2 times, could well raise their spread target for new investments. But the tiering will not make any difference to the rest.
And with the ECB restarting net covered bond purchases in November, it is difficult to see the ECB’s deposit tiering facility — generous as it ostensibly is — making any difference to covered bond spreads.