Central Banking 101: the EONIA heartbeat returns
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The Court Astrologer 
Dear MigeruET
Thanks for your response. I agree with everything you say except about the drainage of liquidity via the 1-week deposits. Each weekly announcement of these from the ECB (ad hoc communications) includes the words: “Fixed term deposits held with the Eurosystem are eligible as collateral for the Eurosystem’s credit operations.”
By the way, I don’t recognise your name. Who are you?
Regards
John Whittaker
Lancaster University UK
“Fixed term deposits held with the Eurosystem are eligible as collateral for the Eurosystem’s credit operations.”
But isn’t that money then unavailable for overnight lending among private banks?
Also, if a bank uses a weekly deposit as collateral for borrowing reserves from the ECB, it will have to pay the marginal rate, which is a penalty of 0.50% (currently: historically it’s been 1%) over what the weekly deposit pays.
I have trouble with the assumption that the SMP sterilisations actually ‘drain liquidity’ from banks. The 1-week deposits are hardly less liquid than the cash deposited, particularly as they are eligible for repo with the ECB.
Moreover, the rate paid on these deposits is a market rate determined by tender with a cap at the main refinancing rate of 0.25%. It is not surprising banks have been reluctant to deposit – the sterilisation ‘failed’ – when eonia has risen above 0.25%. Hence no information is gleaned from these failures beyond what is already in the eonia rate.
Finally, I have a query about the eonia rate itself. It is a weighted average rate for overnight unsecured loans made by reporting banks. However, we are not told about the variation in rates among the banks or the volumes for each bank. I understand that most of the business is between ‘core’ eurozone banks rather than the periphery; if this is true, eonia reflects preferentially deals among those banks that have zero-earning cash in current accounts at the ECB or in the deposit facility. I would be very interested to see any analysis of this so-called liquidity crisis that differentiates between those banks that have reserve deposits against those that are indebted to the ECB under refinancing.
John Whittaker
Lancaster University, UK
John.whittaker@lancaster.ac.uk
I believe the segmentation of the Euro interbank market into “good” and “bad” banks is responsible for the EONIA being anchored around the deposit rate rather than the repo rate. In this chart one can see the change coincides with the arrival of the banking crisis to Europe and the switch from fixed-tender to unlimited-tender in the ECB’s weekly refinancing operations:
I don’t have data on which banks take part in EONIA lending. But if you’re a “bad bank” your cheapest funding is going to be the ECB’s repo rate while if you’re a “good bank” you’re only willing to lend to other “good banks” and you all have a relatively comfortable liquidity position, hence the low rate.
Therefore, I think you’re right and the Eonia “liquidity crisis” reflects tight liquidity among “good banks”. The “bad banks” are still funding at the repo rate.
On the second point: the sterilization failures are of course correlated with high EONIA. The point of mentioning the sterilization failures is that people hyperventilate when this happens about “excess liquidity” being an inflationary risk when this happens. If EONIA is spiking above repo evidently there is no excess liquidity.
And on the first point, the sterilization deposits are weekly deposits, and EONIA is an overnight rate. When the ECB takes a deposit the cash is unavailable for overnight lending. It is in this sense that liquidity is withdrawn. Also, I don’t know how a deposit with the ECB can be eligible for a repo from the ECB. That makes no sense to me.