June 25, 2024

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ECB makes case for keeping balance sheet big

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The European Central Bank must avoid shrinking its balance sheet too much, its chief economist has said, warning this could impair lending and threaten financial stability.

Major central banks flooded the financial system with liquidity in response to a series of shocks over the past 15 years by buying unprecedented amounts of bonds and lending vast sums of money to commercial banks on generous terms.

Now, as rate-setters tighten monetary policy in response to high inflation, officials in the eurozone and elsewhere have started to debate the degree to which balance sheets should return to pre-2008 norms.

“There is a transition going on,” Philip Lane told an ECB conference on Thursday. “I don’t think we should go back to the world of very low bank reserves we had before the global financial crisis.”

Maintaining a larger balance sheet would encourage commercial banks to lend more, provide the financial system with a liquidity buffer to cope with future shocks and give the ECB more “headroom” to avoid interest rates falling back towards zero in future, he said.

His comments underline how the world’s central banks are trying to figure out how big a role to maintain in providing liquidity to the financial system — after pausing the recent monetary policy tightening they launched in response to a surge in inflation. 

Despite 10 successive rate rises by the ECB, a big build-up of reserves, in the form of deposits held at the central bank by commercial banks, remains.

In the eurozone, the level of reserves is €3.7tn above what the region’s lenders are required to hold.

The ECB bought more than 30 per cent of all the eurozone bonds it could, expanding its balance sheet from just over €1tn before the 2008 financial crisis to almost €9tn two years ago. In the past year, it has shrunk close to €7tn, following the expiry of loans…

2023-11-09 08:53:16

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