Regulatory Incentives and the Structure of Euro Area Money Markets (European Central Bank)

Summary

• Unsecured interbank lending entails material regulatory costs, estimated at around 35 basis points for lenders in the second half of 2025.p.3
• Unsecured interbank borrowing incurs an estimated regulatory cost of around 15 basis points for borrowers in the second half of 2025.p.3
• Unsecured interbank trading volumes underlying EONIA declined sharply from €27 billion to €2 billion between 2015 and 2019.p.6
• For a stylised unsecured loan of €100, maintaining capital ratios requires issuing €3.2 of CET1 capital, €0.3 of AT1, and €0.5 of T2 capital.p.12
• Estimated regulatory costs for cash lenders in secured repo transactions range between approximately 2.8 and 6.4 basis points.p.14

Key insights

1. Post-crisis prudential reforms create structural incentives that favour secured repo transactions over unsecured interbank lending.p.3
2. Under the standardised approach for credit risk, unsecured interbank loans to investment-grade counterparties with residual maturity under three months attract a 20% risk weight.p.9
3. The net stable funding ratio assigns a required stable funding factor of 10% to loans to financial institutions with a residual maturity below six months.p.9
4. Cash borrowing increases balance sheet size and leverage ratio exposure, generating an estimated regulatory cost of approximately 15.2 basis points.p.13
5. Cash-driven repo activity has started picking up, supporting liquidity redistribution in an environment with a shrinking central bank balance sheet.p.6
6. Cross-selling and client relationships can lead banks to accept lower margins on money market transactions, obscuring the pass-through of regulatory costs.p.16
7. Reductions in repo volumes and spikes in repo rates around quarter-end reporting dates reflect window-dressing behaviour driven by leverage ratio constraints.p.17