Money Market Update: French bank window-dressing

Summary:

• Year turns in the Eurozone are infamous for banks rejecting deposits, or charging penalty rates. Wholesale clients have become accustomed to such so-called window-dressing behavior by banks, which is intended to help them polish regulatory ratios. Surprisingly, banks in certain member states, chief of which is France, report a sizeable but temporary increase in liquidity balances (i.e. reserve balances) with the Eurosystem over the year turn. To be more precise, French banks ‘borrow’ over the turn, only for these borrowings to be fully reversed in January. Which begs the question, what are the motives for these trades? Publicly available data do not suggest the motive is outright liquidity demand. Then again, the available data leaves much to be desired. It doesn’t allow us to draw conclusions one way or the other.

• We are very much interested in the behavior of banks in France and certain other member states over the year turn. What do these borrowings represent: outright liquidity demand, or something else? And with the emphasis on banks in France, where the liquidity situation is deteriorating rapidly because of the budget crisis. French banks are still liquid, but the pace of the decline in liquidity is simply unsustainable.

• Speaking of the liquidity level in the French banking system, ECB Quantitative Tightening will cease not when the overall level of liquidity in the Eurozone banking system becomes low. Instead, QT will come to an end when reserves become scarce in France or any other key member state. That, or the ECB will have to justify ‘unplugging’ one country from Quantitative Tightening in case of market turmoil. The ECB simply cannot add fuel to the fire by destroying liquidity in a member states that suffers from capital flight.