Covered bonds are becoming the new standard collateral for European bank liquidity
Our main message is that covered bonds have moved beyond their traditional role as a public wholesale funding instrument and are increasingly being used as a strategic collateral tool. This shift reflects the end of TLTRO III, the decline in excess reserves and the need for banks to replace central-bank liquidity with collateral that can be mobilised quickly in private repo markets. Retained covered bonds allow banks to transform mortgage assets into repo-eligible collateral, creating liquidity optionality without necessarily accessing public markets. The key point is that retained issuance is not primarily a sign of funding stress but a deliberate liquidity-management response to a new post-QE environment. As cash buffers decline, collateral quality, eligibility and operational readiness become more valuable than mere balance-sheet size. As such, covered bonds sit at the intersection of funding, liquidity, regulation and profitability. In this new paradigm, the asset class becomes a core component of the European bank treasury toolkit.
Repo markets are showing a structural preference for covered-bond collateral
The growing presence of covered bonds in tri-party repo indicates that the secured-funding market increasingly recognises their collateral efficiency. Government bonds remain the dominant collateral class, but covered bonds have become the second-largest bucket, reflecting the high degree of repo acceptance, rating stability and favourable haircut treatment. This matters because repo markets serve as a real-time clearing mechanism for collateral quality, liquidity and counterparty confidence. As banks and cash lenders reassess the relative value of sovereign, SSA, credit and securitised collateral, covered bonds are benefiting from a superior combination of safety and spread. Their lower haircut volatility compared with ABS and other credit collateral reinforces their attractiveness for both term funding and collateral transformation. This repo demand also supports covered bond spread resilience relative to EGBs and SSAs. We can thus frame covered bonds not just as an investment product, but also a collateral currency in the secured-funding ecosystem.
Retained issuance is a liquidity-management signal, not a public-market distress indicator
The sharp rise in retained covered bond issuance, particularly in the Netherlands and Spain, should not be taken as evidence that issuers are being forced out of benchmark markets. Public covered bond markets remain open, new issues have performed well, and issuer access has been healthy. The surge instead reflects the growing need to create pledgeable collateral for repo funding, collateral upgrade trades, ECB pre-positioning, and contingency liquidity planning. Banks are using retained covered bonds to optimise collateral pools and improve profitability, rather than simply to cover hidden funding gaps. This distinction is important because it limits the read-across from retained supply to public supply cannibalisation. Retained covered bonds should be understood as a flexible treasury instrument that can be activated when repo economics, regulatory needs, or market timing make it attractive. In our view, retained issuance represents a structural development in liquidity practice rather than a cyclical funding weakness.
ILAAP and CBC are transforming collateral from a balance-sheet asset into a supervisory liquidity requirement
The regulatory framework is a key driver of the rise in retained covered bonds. Under ILAAP, SREP liquidity reviews and ALMM maturity-ladder monitoring, supervisors increasingly focus on whether banks can monetise liquidity in stress rather than merely reporting compliant ratios. Counterbalancing Capacity is central to this shift because it captures assets and funding sources that can be mobilised quickly to cover cash outflows across stress horizons. Retained covered bonds are particularly valuable in this context because they are not LCR-eligible for the issuing bank, yet they can still count as monetisable CBC if they are repo-eligible or pre-positioned. This makes them extremely important for survival-horizon management, intraday liquidity, margin calls and central-bank access. In practice, banks must demonstrate that liquidity is executable, not theoretical. As such, covered bonds serve as a regulatory liquidity bridge between collateral availability, repo monetisation and supervisory credibility.
The post-TLTRO world is compelling banks to replace excess reserves with monetisable collateral infrastructure
During the TLTRO period, banks could rely on abundant central-bank liquidity and large cash reserves to maintain liquidity comfort. That environment has changed, as TLTROs have been repaid, QE portfolios have rolled down, and excess liquidity has fallen across the Eurosystem. The report identifies this transition as a shift from a “hold reserves” model to a “hold mobilisable collateral” model. In this model, banks need assets that can be pledged, repoed, pre-positioned, and operationally converted into cash under stress. Covered bonds are particularly well suited to this role because they combine high ratings, legal robustness, dual recourse, Eurosystem eligibility, and deep repo familiarity. This explains why retained issuance has risen since 2023, even as public market access has remained available. The decline in reserves is, therefore, not simply reducing liquidity; it is changing the form in which liquidity must be held.
The interaction between excess liquidity and retained covered bonds has entered a new third phase
We identify three distinct phases in the relationship between retained covered bonds and Eurosystem liquidity. The first, in 2020-21, was dominated by ultra-cheap TLTRO III conditions, with banks creating retained covered bonds to pre-position collateral and access central-bank liquidity. The second, from 2021 to 2023, saw retained issuance decline as excess liquidity peaked, public issuance recovered and TLTRO repayments accelerated. The third, from 2023 onwards, is the most important, as retained issuance has risen again despite falling excess liquidity. This shows that the driver is no longer cheap ECB funding alone, but broader repo activity, regulatory pressure and collateral optimisation. Germany, France, Italy and the Netherlands broadly follow this pattern, while Spain remains structurally more reliant on retained issuance. The key conclusion is that retained covered bonds have become embedded in the liquidity cycle rather than merely reacting to temporary stress.
Covered bonds are gaining relative-value appeal as sovereign and SSA collateral becomes abundant
Our relative-value thesis rests on the contrast between abundant EGB and SSA supply and a more constrained covered-bond supply. QT and higher fiscal deficits are increasing the amount of sovereign and supranational paper available to the market, reducing the scarcity value that previously supported those assets in repo. Covered bonds, by contrast, face more moderate supply expectations because mortgage lending remains subdued and senior unsecured funding has often been relatively attractive for issuers. This creates a technical backdrop in which covered bonds can remain scarce, highly rated and collateral efficient. Investors also appear increasingly comfortable holding financial risk rather than rates or fiscal risk, particularly as sovereign downgrade risk becomes more visible. As a result, covered bonds can trade at historically tight levels versus SSAs while still retaining strong repo demand. In this framework, collateral scarcity and regulatory utility reinforce the case for covered-bond outperformance.
Term repo makes covered bonds both a funding-stability instrument and a collateral asset
We show that banks are increasingly using covered bonds in term repo transactions, typically with maturities of six months to two years, to improve funding durability and liquidity resilience. This use is particularly relevant because term repo can support survival horizons, reduce rollover risk and contribute to more stable funding profiles. Covered bonds are attractive in that structure because they are widely accepted, operationally efficient and subject to relatively favourable haircuts. Retained covered bonds can also be used in collateral upgrade or downgrade trades, where banks exchange them for cash or lower-quality collateral to optimise profitability. This turns covered bonds into an active balance-sheet management tool rather than a passive stock of securities. The strategy is consistent with ILAAP and CBC objectives because it strengthens the bank’s ability to monetise assets under stress. Covered bonds therefore link repo execution, NSFR considerations, collateral mobility and supervisory liquidity planning.
Covered bonds are not an NSFR silver bullet, but they become strategically valuable when collateral monetisation is included
From an NSFR perspective, retained covered bonds are more nuanced than their collateral strength might suggest. At origination, they do not generate Available Stable Funding (ASF) because no third-party liability is created, while the mortgages placed in the cover pool may increase Required Stable Funding (RSF) through encumbrance. The key regulatory offset is that CRR treatment for eligible covered bonds can limit the RSF burden, with mortgages supporting the covered bond nominal and mandatory or contractual overcollateralisation generally attracting an 85% RSF treatment rather than a full 100% charge. Excess overcollateralisation that remains freely withdrawable may continue to attract the ordinary mortgage RSF treatment, which mitigates the negative NSFR impact.
The equation changes when the retained covered bond is used in a repo with a maturity of more than one year, as the repo liability can generate 100% ASF while the collateral side may remain subject to 85% or 65% RSF, depending on the cover-pool composition. This makes long-term repo against retained covered bonds economically NSFR-neutral or slightly positive, particularly where repo economics are attractive and the collateral would otherwise remain trapped on the balance sheet. Article 428f can make the treatment materially more powerful, but in practice it is narrowly applicable, mainly to structures with genuine asset-liability interdependence, such as Danish-style pass-through or conditional pass-through formats. As such, the real strength of retained covered bonds lies less in pure NSFR optimisation and more in the combination of collateral transformation, repo monetisation, CBC relevance, liquidity mobility and contingency funding value.
The main risk is not the covered bond thesis itself, but a change in the rules that determine collateral value
The key risk factors are concentrated in the regulatory and repo market framework rather than in near-term public market access. Any adverse change to ECB collateral eligibility, valuation haircuts, close-link rules, second-best rating treatment or operational procedures could reduce the repo efficiency of covered bonds. Rating migration in sovereigns or covered bonds could also affect collateral treatment, particularly when fiscal risk or issuer-specific pressure increases the sensitivity of haircuts. A sharp rise in public covered bond issuance or a large ABS pipeline could weaken the scarcity premium that currently supports the asset class. Repo microstructure risks also matter, as balance-sheet constraints, concentration caps, GC-specials basis compression or CCP margin changes could erode carry opportunities. Even so, these risks do not invalidate the central thesis; they define the monitoring framework for it. Our main conclusion is that covered bonds are becoming a strategic meeting point between repo market plumbing, ILAAP discipline and CBC-driven bank liquidity management.