Key banking indicators suggest that European banks are slowly returning to health and are no longer hoarding cash.
European banks have scaled down the cash they hold with the European Central Bank (ECB), known as excess liquidity while overnight lending rates have normalized.
The current trend has given rise to hopes that the counterparty risk has receded and European banks are lending each other again as fears of deepening Eurozone debt crisis slowly retreats.
In a speech delivered last week, Jürgen Stark – Executive Board Member of ECB, said the ‘market sentiments’ are improving. As market conditions continue to improve, ECB may claw back some of its exceptional lending practices it initiated since the collapse of Lehman Brothers in 2008.
For the first time since June 2009, overnight bank lending rates – known as Eonia, has jumped over the official ECB lending rate of 1 percent while latest figures suggest that excess cash held with ECB has come down to €7 billion ($9.5 billion) from €350 billion, witnessed in June 2010.
The ECB is set to meet on Thursday to revise the Eonia rate, and any upward movement will show the gradual return of confidence in Eurozone banks.
“Confidence has improved in the eurozone banking system as things are normalising. This could be a sign that banks are lending to each other again” said Don Smith – an economist at Icap.
However, market sentiments can quickly turn around, he cautions while many economists point out that many banks in the peripheral countries of Portugal, Ireland and Greece are unable to tap the money market and remain solely dependent on ECB loans.
Before the European financial crisis happened, typical Eonia rates hovered around ECB’s benchmark rate while banks would maintain little excess over statutory reserve with ECB.
However, since the market crash, Eonia rates have fallen below benchmark lending rates as banks preferred stashing their money with the ECB rather than lending each other.
Although the ECB has halted its ‘exit strategy’ after the debt crisis exacerbated last year, it has however, stopped providing unlimited liquidity to banks on 6 months and 12 months basis.
The ECB is expected to announce its liquidity policy for the second half of 2011 after its scheduled meeting in March this year.