Analysts warn the European Central Bank faces short-term money market turmoil unless it clarifies what tools lenders can use to meet liquidity needs as it winds down quantitative easing.

Having grown used to ample liquidity in the era of quantitative easing, commercial banks’ treasury departments are coming to terms with a less liquid environment, as the ECB and other major central banks seek to shrink their balance sheets.

While the ECB has announced plans to introduce new tools to help lenders address this challenge — in the form of a new structural bond portfolio and a fresh series of structural long-term refinancing operations — the exact details of each remain unknown.

“The question is whether you want, as a central bank, to wait to see some volatility in interest rates before unveiling your strategies,” said Sylvain Broyer, chief Emea economist at S&P Global Ratings, who noted the ECB has yet to give a timeframe for releasing details about the schemes.

While an April 2025 ECB survey revealed that just 17 per cent of banks are already constrained in their reserves, S&P Global Ratings expects the number of banks that are reserve constrained to “gradually increase” over time as reserves come down. 

The rating agency predicts the ECB’s quantitative tightening programme will conclude before the end of next year, with banks likely to seek out further information on the applicability of the central bank’s structural bond portfolio and LTROs before then.

The ECB’s wait-and-see approach on updating the market about such tools is “not without risks”, analysts say.

Some European lenders could face “greater funding market volatility” with “even a modest mismatch between minimum reserve needs and liquidity”, said Glenn Handley, owner of securities financing consultancy SecFin Solutions.

Banks that are best placed to handle the ECB’s unwinding of QE and tightening liquidity include certain standout names based on the latest 2025 EU-wide stress tests and market performance.

“Those would be BNP Paribas, ING, Santander, Nordea, KBC, OTP and SociĂ©tĂ© GĂ©nĂ©rale, as these have demonstrated strong capital positions, proactive liquidity management, digital transformation, and a diversified funding base,” Handley said.

Conversely, smaller and medium-sized banks in the periphery, notably some in Italy and Spain, and a number of German Landesbanken, may face a tougher time, he added.

“This is due to a combination of higher exposure to sovereign risk, cost pressures, and more acute sensitivity to market funding conditions as central bank liquidity is withdrawn,” Handley said.

BoE takes the lead

S&P Global Ratings analyst Nicolas Charnay contrasted the Bank of England’s approach to quantitative tightening, which has been “more direct”, with the ECB’s, which is “slightly more ambiguous”.

“The BoE has called on the UK banks to use its [repo] facilities saying ‘this is the new normal’ and is doing more rapid tightening while the ECB has not done this,” he said.

The BoE’s £420bn unwinding of its asset purchase facility and term funding scheme — a 38 per cent reduction from the 2021 peak — has occurred relatively seamlessly in comparison with the ECB’s programme, according to S&P Global Ratings.

New repo instruments are slowly replacing the previous forms of liquidity while the BoE at the current pace of balance sheet reduction should end quantitative tightening by early 2027, the rating agency noted.

The ECB is set to review its operational framework, which steers short-term money market rate tools and policy, in 2026.

S&P Global Ratings notes that European banks have not yet tapped the ECB’s two current existing refinance tools: main refinancing operations and longer-term refinancing operations, as the majority of banks feel they have adequate reserves.

Bank reserves at the ECB have diminished by just over 40 per cent over the past three years to €2.8tn in August 2025, with banks paying down their borrowings under the ECB’s previously targeted LTROs.