Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Why Eurozone Cash Is Piling Up While Banks Hoard Reserves
Transcript
- Lucas: So here's a number that keeps me up at night: Eurozone banks are currently parking over €4.2 trillion in overnight deposits at the European Central Bank. That's up from about €3.8 trillion six months ago. And this is happening while the ECB has cut its main rate by 75 basis points across two moves this year. Luna: So the central bank is trying to encourage lending by lowering rates, and instead, banks are just handing the money right back to the central bank? Lucas: Exactly. They're earning the deposit facility rate, which is currently 3.25 percent, on those reserves. And they're choosing that over lending to businesses at, say, 5 or 6 percent. Which tells you something about how risky they perceive the real economy to be right now. Luna: Let's put a concrete example on it. I was looking at Italian SME lending data yesterday. In June, new loans to small businesses in Italy fell another 4 percent year-over-year. That's the seventh straight monthly decline. Lucas: Right, and Italy and Spain are where this bite is hardest. The banks there are still nursing legacy non-performing loan portfolios from the last downturn, so they're especially cautious. But even German banks—which have cleaner balance sheets—are sitting on record excess reserves. Luna: So is the ECB's rate cut just not working? I mean, we've had two cuts—one in April, one in June—and lending volumes are still contracting. Lucas: That's the big question. The traditional transmission mechanism says lower policy rates should pull down market rates, which should stimulate borrowing. But we're seeing what economists call a 'lending strike.' Banks are tightening credit standards faster than the ECB is cutting rates. Luna: I saw the ECB's Bank Lending Survey for the second quarter: it showed that banks expect to tighten standards further in Q3. So the trend isn't reversing anytime soon. Lucas: And the ECB's own data shows that the average interest rate on new loans to non-financial corporations actually rose in May to 4.82 percent, even though the policy rate was cut in April. That's the opposite of what should happen. Luna: So banks are widening spreads. They're keeping loan rates high to protect margins, and they're parking the liquidity at the ECB because it's safe, liquid, and pays a decent return. It's rational for them individually, but collectively it's strangling the recovery. Lucas: Right. And this connects to a broader theme we've touched on before: the Eurozone has a fragmented banking system. An SME in Madrid doesn't have the same access to credit as an SME in Munich, because Spanish banks are more constrained. The single monetary policy hits different transmission channels. Luna: One thing I keep wondering: wouldn't the ECB want to make the deposit facility less attractive? Like, cut the rate on those excess reserves to push banks to lend? Lucas: They could, but there's a catch. The ECB introduced a two-tier system for reserve remuneration a few years ago. A portion of reserves—about six times the minimum reserve requirement—earns the deposit rate. Anything above that earns zero. So technically, banks are already penalised for excess liquidity above that threshold. Luna: But they're still piling up. So the penalty isn't high enough, or the lending environment is just too unattractive. Lucas: I think it's the latter. Look at the macro backdrop: Eurozone GDP growth annualised is about 0.6 percent—well below the US. Inflation is still sticky at 3.5 percent, especially in services. And the geopolitical picture—renewed tensions in the Strait of Hormuz, China slowing—none of that screams 'borrow to expand.' Luna: There's also the hangover from TLTRO. Remember those targeted longer-term refinancing operations? Banks borrowed cheaply from the ECB and then used some of that to buy government bonds. Now that TLTRO repayments are coming due, they're holding on to cash to meet those obligations. Lucas: Good point. The TLTRO III repayments started in earnest this year. Banks have to return about €500 billion by the end of 2026. So they're building up precautionary reserves. That's another reason the excess liquidity isn't flowing into the real economy. Luna: So what would actually unlock lending? A clearer economic outlook? More aggressive ECB action? Lucas: I think the ECB is in a bind. If they cut further—say, 50 basis points in September—they risk reigniting inflation, especially if energy prices spike again. If they hold, the lending freeze persists. And if they try to force banks to lend by penalising reserves more, they could trigger a credit crunch. Luna: On that topic of making sense of the economy—if walking through these dynamics with us has made something click, we always appreciate when listeners support the show. It keeps us independent and ad-free. You can do that at buy me a coffee dot com slash fexingo. Lucas: Yeah, genuinely helps us keep digging into these numbers. So back to the bind the ECB is in—one option they're reportedly discussing is a new targeted lending program, akin to a TLTRO IV, but with more conditions tied to actual SME lending. Luna: I've heard that too. The idea is to offer banks cheap funding specifically for new loans to small businesses, and maybe even subsidise the interest rate for the borrower. But that's a fiscal tool dressed up as monetary policy. Lucas: Exactly, and that's where it gets politically tricky. Some Northern European countries are wary of what they see as quasi-fiscal operations by the ECB. They'd rather see governments step in with credit guarantees or direct lending. Luna: But the German government is constrained by its debt brake, and Italy already has high debt. So there's a coordination failure. Lucas: In the meantime, the data keeps coming in. July's PMIs are due next week, and the consensus is for another contraction in manufacturing. Services might hold up, but the divergence is getting wider. Luna: It feels like the Eurozone is stuck in a low-growth, high-inflation, tight-credit equilibrium. And none of the actors—ECB, banks, governments—seems able to break out of it alone. Lucas: Right. And the longer this persists, the more damage it does to the productive base. SMEs account for about two-thirds of employment in the Eurozone. If they can't access credit to invest or even manage cash flow, we're looking at a slow-motion erosion of capacity. Luna: One last data point: the ECB's own staff projections from June show GDP growth of just 0.8 percent for 2026. That's with the rate cuts already baked in. If lending doesn't pick up, they'll have to revise down again. Lucas: So the question becomes: do we need a recession to clear the system? Or can policy find a way to unstick credit without triggering worse inflation? I honestly don't know the answer, but it's the most important debate in European macro right now. Luna: And it's one we'll keep following as the data comes in.