The liquidity coverage ratio of EU banks declined in the first half of 2022 but is still well above the minimum requirement

The European Banking Authority (EBA) today published its Report on liquidity measures, which monitors and evaluates the liquidity coverage requirements currently in place in the EU. The liquidity coverage ratio (LCR) declined to 166% in June 2022. The fall was due to an increase in outflows driven by higher interest rates and volatility which led to a decline in asset prices during the first half of the year. The evolution of banks’ LCR levels is particularly relevant given the uncertain economic outlook with high levels of inflation and the process of normalisation of the monetary policy. EU banks hold materially lower liquidity buffers in foreign currencies, particularly the USD, which requires enhanced monitoring by banks and supervisors to avoid excessive vulnerability to disruptions in the foreign exchange markets.

The EBA Report on liquidity measures shows that EU banks LCRs declined in the first half of the year due to an increase in outflows following the outbreak of the war in Ukraine and the general macroeconomic uncertainty. However, despite some reduction in the EU banks’ LCR levels, the LCR buffers remain significantly above the minimum requirement.

The process of normalisation of the liquidity-enhancing monetary policy measures by EU central banks started in 2022 and is expected to continue in the coming years.  In particular, the bulk of the ECB’s Targeted Longer-Term Refinancing Operations (TLTRO-3) operations will be maturing in 2023 and the run off of securities accumulated by EU central banks in the asset purchase programmes will continue with the effect of reducing liquidity in the EU financial system going forward. Under this scenario, it is crucial to keep monitoring the evolution of banks’ LCR levels.

EU banks continue to hold materially lower liquidity buffers in some foreign currencies, in particular US dollar. This situation increases banks’ vulnerability for disruptions in foreign exchange markets and may make them overly dependent on existing non-standard policy tools, such as the central bank foreign currency swap lines. Moreover, in 2022, rising geopolitical tensions, high volatility in key commodity prices and increasing uncertainty about the global macroeconomic outlook led to an appreciation of the US dollar against most European currencies, which made USD denominated funding more expensive for EU banks.  In this context, significant currency mismatches should be closely monitored by the affected banks and their supervisors.

The current Report also contains analyses that assess the impact of the LCR on the banks’ lending activities, and on the interaction between the LCR and the net stable funding ratio (NSFR) metrics.

Note to the editors

1. This Report has been drafted in accordance with Article 509(1) of the Capital Requirements Regulation (CRR).
2. Article 412(1) of the CRR foresees the possibility of monetising liquid assets during times of stress (resulting in an LCR below 100%) as maintaining the LCR at 100%, under such circumstances, could produce undue negative effects on the credit institution and other market participants.
3. The regulation does not foresee a minimum requirement for LCR in foreign currencies. However, article 8(6) of the LCR DR requires banks to ensure that the currency denomination of their liquid assets is consistent with the distribution by currency of their net liquidity outflows and includes a discretion to competent authorities to require credit institutions to restrict currency mismatches by setting limits on the proportion of net liquidity outflows in a currency that can be met during a stress period and by holding liquid assets not denominated in that currency.
4. The results of the Report on liquidity measures are presented separately for G-SIIs and O-SIIs and other banks (non G-SIIs or O-SIIs). Some figures are presented by country.