Central bank reserves in the Eurosystem have significantly decreased, dropping from a peak of €4.9 trillion in 2022 to €2.6 trillion by early 2026. This decline is due to the Eurosystem's balance sheet normalization. While reserves are still ample, their distribution across banks is uneven, suggesting some banks will need to source reserves sooner than others as the balance sheet continues to shrink. Money market rates, particularly secured repo rates, have moved closer to the deposit facility rate (DFR) set by the European Central Bank, which is currently at 2.0%.
An annual Eurosystem survey indicates that banks representing 26% of all euro area banking assets are now operating near their preferred reserve levels, an increase from 15% a year prior. This group includes large institutions and active liquidity managers. Projections suggest reserves will continue to decline by approximately €470 billion annually, with 50% of total banking assets expected to be held by banks nearing their preferred reserve levels by the end of 2026. This trend implies that banks will need to manage their liquidity more actively.
Commercial banks are actively using money markets to redistribute central bank reserves, with no signs of fragmentation. The repo market, a key mechanism for borrowing and lending reserves, is seeing increased participation from banks, especially those closer to their preferred reserve levels. Although the share of overnight repo trades above the DFR has risen to 40%, this does not indicate funding pressure for banks, which generally borrow at rates just below the DFR. Instead, the higher repo rates primarily reflect demand from hedge funds, which are willing to pay a premium to fund their investment strategies in other market segments. The demand for Eurosystem's standard refinancing operations (SROs) remains low due to favorable money market conditions, with rates generally below the main refinancing operation (MRO) rate of 2.15%.
