For over ten years already, the Eurosystem has supported banks with extended liquidity supply. At the outset of the crisis, this support was intended to ease liquidity tensions in the banking system. The Eurosystem, fulfilling its role as lender of last resort, provided banks with as much liquidity support as required at a fixed interest rate. Later, long-term liquidity support was provided to improve monetary transmission via banks. These measures were needed because the money markets had dried up, posing risks for lending and the economy.
Liquidity support to banks is important and effective
The Occasional Study shows that the central bank can play an important complementary role when money markets do not perform well. In other words, when the money markets dry up, there is a role for the central bank to play as lender of last resort. Providing solvent banks with liquidity support is very important for the economy. It helps financial institutions and markets to also continue to be able to function in a crisis. Banks can continue to provide for instance loans and payment services when they can count on liquidity, for a longer period where necessary. The study concludes that in a crisis there must be no uncertainty about the availability of such liquidity support. It must be clear that the central bank is willing to meet additional demand for liquidity, if required. This central bank liquidity must be accessible, with no stigma attached, to ensure that liquidity support is as effective as possible.
Liquidity support went to a small group of banks
The liquidity support the Eurosystem provided mainly ended up with a small proportion of banks in the euro area: less than five percent of the banks received over ninety percent of allotted liquidity. Moreover, these banks made long-term use of the liquidity support. Even in the period when the markets had calmed, they continued to borrow relatively heavily from the Eurosystem (Figure 1). This suggests that a small fraction of banks have become structurally dependant on central bank financing.
Figure 1: Liquidity support and money market stress indicator in the euro area