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Don't We All Have Front-Loaders?

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by Tracy Alloway on Jul 14 08:20.

Front-loading time is upon us.

For today is the start of the European Central Bank’s new maintenance period.

Eurozone banks all have reserve requirements which they have to fulfil with their local central banks for every 21 to 42-day maintenance period — and the latest one starts Wednesday, July 14.

The reserve requirement is an average across the maintenance period, but banks often have a tendency to ‘front-load’ their requirements to avoid coming up short at the end of that time.

This is something that tends to happen especially during a crisis, and indeed the ECB has previously moved to accommodate it. From a recent Bank for International Settlements working paper on funding liquidity risk:

As central bank operations are primarily monetary policy operations with a purpose to steer market rates close to the policy rate, the ECB made use of this option to a larger extent after the beginning of the crisis. During this period the ECB “front-loaded” liquidity requirements. Front loading is an allotment practice, where the central bank provides liquidity above the benchmark in the beginning of the maintenance period, and close to or just below the benchmark towards the end of the maintenance period, possibly in combination with liquidity absorbing operations. In doing so, the central bank makes sure that banks fulfil their reserve requirements early in the maintenance period. In times of crisis this helps to stabilise the overnight rate.

Combine the end of the ECB’s €442bn 12-month Long-Term Refinancing Operation with some lingering eurozone bank jitters (especially ahead of the stress tests) and perhaps you have a formula for some formidable front-loading. Or as Risk puts it in a Wednesday article, there’s “heightened event risk”.

The concern is that, with eurozone liquidity having dropped from an estimated €315bn to an about €174bn after the LTRO expiry, a rapid build-up in reserves could endanger whatever excess remains.

Quotes Risk:

“At the start of a new reserves period, when funding is a little bit stressed, people look to do reserves as part of their funding. At the start of the last reserves period, we saw people front-loading between €120 billion and €130 billion over the first few days, which is fairly typical behaviour,” says one global head of liquidity management at a major European bank.

“There has been a liquidity surplus of €340 billion and it has come down to around €100 billion. A surplus of €100 billion sounds like a lot of money, but at the start of a new reserves period it can disappear, and anyone who needs short-dated cash will just find it’s not there. Consequently, rates can go quite sharply higher. There’s certainly a lot of event risk with the ECB right now.”

Others of course think differently:

“It’s possible at the start of the new maintenance period that banks will be nervous and keen to build their required reserves quickly, which means there will be less liquidity in the market. So you could see some tensions for a few more days, but we tend to believe it is overdone now and liquidity will continue to be quite generous into the end of the year,” says [socGen's global head of rates strategy Vincent] Chaigneau.

Yesterday, Tuesday, the last day of the last reserve maintenance period, the ECB launched a one-day liquidity absorbing operation to drain what it called a “large positive liquidity imbalance.”

How much can things change in a day?

We’ll soon find out.

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Sorry Laura. Bit too technical for me. If you have a little time, could you please explain just the main point here? Cheers. ToW.

No chance ToW, I have less idea than you, I am sure of that.

I just thought the unintended washing machine analogy highly appropriate - Lather, rinse, & the optional, but ever more popular, repeat.

There could be a problem with top loaders though?

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