European Banks Say Goodbye to Easy Money

European banks have come a long way since the 2008 financial crisis and the sovereign-debt crisis that followed in the eurozone. Banks are better capitalized, have fewer bad loans and are more heavily regulated. 

Still, the repayments will mark a milestone in the ECB’s efforts to wind down support. Investors remain on edge about the strength of the global financial system following March’s banking turmoil, which was triggered in part by recent, rapid rises in interest rates. The ECB last month lifted its benchmark policy rate to 3%, the highest since 2008.

The end of the program, known as targeted longer-term refinancing operations, or TLTROs, could increase the pressure on more fragile eurozone banks and economies, European banking regulators and the International Monetary Fund have warned recently.

“Banks in some southern European countries that continue to rely heavily on short-term TLTROs tend also to be the same ones that do not have enough excess liquidity to repay,” the IMF wrote in its most recent financial stability report. 

JPMorgan analysts estimate European banks will borrow roughly €150 billion this year to replace the loans. Banks may also sell government bonds or other assets, which could drive up interest rates. In the longer term, banks may need to rely more on more expensive wholesale funding or cut lending, which could weigh on economic growth.

“Banks have been getting liquidity support from the ECB since 2011,” said Corinne Cunningham, head of credit research at U.K. firm Autonomous, a unit of . “It’s been a really long time to now switch and expect them to be able to fund themselves entirely independently.”

Ms. Cunningham said she expects smaller banks with weaker market access to be most affected.

Italian banks, once a weak link in the European financial system, will be in the spotlight. 

They account for nearly 30% of the TLTROs that still need to be repaid and, unlike banks in Germany and France, don’t have enough extra cash parked at central banks to cover the repayments. Italian banks had €328 billion in loans outstanding as of February, data from Société Générale shows, and €245 billion in excess reserves. 

Intesa Sanpaolo SpA, the country’s biggest lender, can fully pay back its €76 billion in TLTROs using €98 billion in excess reserves it had at the end of 2022, said Alessandro Lolli, head of group treasury and finance at the bank. While it won’t need to sell assets or raise new funds for repayments, Mr. Lolli said the bank plans to double its borrowing from wholesale markets to €10 billion this year.

“The system doesn’t need this life support anymore,” he said. “The ECB was overly present in the market for good reasons. Now it’s going to be less present and institutional investors who were not present are coming back.”

UniCredit SpA, Italy’s second-largest bank, is also able to repay its outstanding loans with its excess reserves, according to a company spokesperson.

Smaller banks such as Banco BPM SpA and Banca Monte dei Paschi di Siena SpA have less cash on hand for repayments. BPM had €26.7 billion in TLTRO loans at the end of last year, versus €13.1 billion in cash and equivalents. Monte dei Paschi had €19.5 billion, versus roughly €12 billion in cash. 

A spokesperson for Monte dei Paschi declined to comment. BPM didn’t respond to a request for comment.

Italian banks have other things they can sell to raise cash and may need to unload roughly €55 billion in government bonds or other assets to make repayments, said Jorge Garayo, a rates strategist at Société Générale. That extra supply could weigh on the broader market for Italian government bonds and drive up borrowing costs.

“€55 billion is not a small amount,” Mr. Garayo said. “Banks did know from the time they got the funds that in June this would happen, so they may have been preparing for this.”

Italian banks will owe another €148 billion after the June repayment.

Cheap long-term funding has been a key element of the ECB’s efforts to bolster the economy since 2014, alongside years of rock-bottom interest rates and massive bond purchases. In June 2020, the central bank essentially began paying banks to keep lending throughout the pandemic, offering loans with rates as low as minus 1%.

Some banks also boosted profits by taking the loans and redepositing them back at the ECB to earn higher interest. The central bank changed the terms of the program last November to make the loans less attractive and encourage banks to start repaying. 

Some market participants say the banking system is well-placed to weather the changes.

European bank funding has become more stable in recent years, relying less on wholesale markets and more on a relatively stable base of customer deposits, said Mondher Bettaieb Loriot, head of corporate bonds at Swiss asset manager .

“People don’t tend to switch banks and move deposits around in Europe, it’s not the tradition,” said Mr. Loriot, who is bullish on European banks. 

Andrea Costanzo, an analyst at DBRS Morningstar, said banks also will need less funding as loan demand slows alongside the economy. Banks can charge more for loans as rates rise, which should offset higher funding costs, he said.

Analysts and investors will watch a metric known as the liquidity coverage ratio, which measures how many easy-to-sell assets, such as bonds, a bank has versus its deposits. That measure shrank to a systemwide 164.7% at the end of last year from 174.7% a year earlier, according to the European Banking Authority. But it remains well above the 100% regulatory minimum threshold.

—Patricia Kowsmann contributed to this article.

Write to Chelsey Dulaney at [email protected]