The European Central Bank (ECB) is intensifying its scrutiny of banks’ liquidity reserves and is expected to impose stricter requirements on individual firms later this year, according to informed sources.
In its annual review of banks’ risk profiles, the ECB is likely to place greater emphasis on the management of liquid funds, including the possibility of raising key metrics such as the liquidity coverage ratio. These sources, who requested anonymity due to the sensitive nature of the matter, also mentioned increased engagement between banks and the ECB on this issue.
The recent collapse of Credit Suisse Group AG and several US lenders, including Silicon Valley Bank, has raised doubts about the preparedness of banks to withstand deposit pressures and the efficacy of metrics used by investors and regulators to assess their crisis resilience.
While liquidity has always been a vital aspect of banking oversight, regulatory authorities have recently prioritized issues related to bank capital and credit risk in the context of low interest rates. However, the ECB began urging banks to pay closer attention to liquidity in late 2021 due to higher inflation signaling rising funding costs. The recent collapses of US lenders have further heightened scrutiny in this area.
According to the sources, the ECB is expected to receive the preliminary findings of its annual risk review during the summer. Later this year, officials will categorize banks into different groups based on the vulnerability of their business models to funding outflows.
Wealthy client deposits are likely to receive particular attention as individual withdrawals can rapidly deplete a bank’s liquidity reserves, as was evidenced by the crisis at Credit Suisse. Market funding and retail clients’ confidence in the safety of their savings are also expected to be relevant factors.
Swiss regulators had declared Credit Suisse’s liquidity position to be satisfactory just days before its emergency weekend rescue by competitor UBS Group AG. However, at that point, Credit Suisse was on the verge of collapse, even with the assistance of a central bank lifeline.
European bankers and regulators have been eager to emphasize that Credit Suisse was an isolated case and that recent turmoil in the US does not directly translate to the European region. Unlike the US, the euro area has not experienced a similar run on banks, primarily because all lenders in the bloc are subject to liquidity regulation. Additionally, European banks exhibit lower average exposure to interest rate risk in their banking portfolios compared to US firms, as noted by the ECB.
European banks are required to hold more high-quality liquid assets than what they anticipate would be withdrawn over a 30-day period of stress. The ECB has the authority to increase this requirement, known as the liquidity coverage ratio, although officials publicly acknowledge that this has been a rare occurrence.
According to data from the European Banking Authority, the weighted average liquidity coverage ratio for European banks was 165% in the fourth quarter, well above the minimum requirement of 100%. While individual banks disclose their own figures, they generally do not reveal any additional requirements beyond the minimum.
As an alternative to raising the liquidity coverage ratio threshold, the ECB may criticize individual banks for the quality of their reserves or their ability to manage them, according to the sources. Banks with smaller buffers than their peers may be notified of their underperformance, thereby increasing pressure to improve reserves or potentially receive a lower score in risk management assessments.
Recent developments, particularly the speed at which depositors and other market participants make decisions based on information, highlight the need for “increased attention” to bank liquidity and funding, said Andrea Enria, the ECB’s top oversight official. Speaking to European finance ministers on Monday, Enria emphasized that with monetary policy tightening, the sustainability of banks’ funding plans has become a priority, resulting in enhanced focus on liquidity and funding risks in supervisory priorities.