Address by Mario Draghi, President of the ECB,
on the occasion of receiving the ESMT Leadership Award 2013,
Berlin, 13 June 2013
Good afternoon.
It is a great honour to receive this award for Responsible Leadership and I would like to thank Mario Monti for his kind introductory words. I regret that I am not able to join you in person today in Berlin but am pleased I can address you via Video.
The fact we have a single currency and a European Central Bank is itself testament to the role of leadership. Many of you are too young to remember, but those of us who can recall Europe 20 years ago know how unimaginable it once was to speak about a single currency. Today, it is an integral part of our lives.
But as this award reminds us, the key aspect of leadership is responsibility. In the words of Peter Drucker, “rank does not confer privilege or give power. It imposes responsibility”.
As you know, the primary responsibility of the ECB is to maintain price stability in the euro area – to secure the value of our common currency. We take this responsibility with the utmost seriousness as it directly affects the lives of 330 million citizens of the euro area. Since the launch of the euro in 1999, we have fulfilled our mandate even through difficult times. We will continue to fulfil this task.
I am very proud to be personally contributing to the historic project that the euro represents as the most tangible sign of European integration. But this pride is accompanied by a deep feeling of responsibility.
There is no doubt that the recent period of economic and financial turbulence has tested us in new ways. We have had to take new measures to fulfil our responsibility for price stability. We had to look at all the data, assess all the evidence, and decide what measures were necessary to ensure the stability of the euro.
One such decision was to combat market fragmentation by Outright Monetary Transactions (OMT), based on a country committing itself to strict and effective conditionality under an EU/IMF economic adjustment programme.
At almost one year from its announcement, the benefits of OMT are visible to everybody:
Banks have been able to re-access the market, for both funding and for raising capital, and the strong divergence in funding costs across constituencies has receded.
Deposits have flown back: banks in stressed countries have seen the deposits by the euro area money-holding sector increasing by about 200 billion euros since August 2012.
Another sign of normalisation, and a very important one for German savers, has been the increase in German government bond yields, previously suppressed by panic-driven safe-haven flows, which have edged up by around 25 basis points.
And Target balances, which are a summary indicator of fragmentation, have declined by 285 billion euros, or 25%, since the peak last year, and now are at the same level as in late-2011. Therefore, also perceived risks for creditor countries such as Germany have greatly diminished.
The establishment of OMT has therefore been beneficial to everybody: sovereigns, corporations, banks as well as individuals, and it has benefited both periphery and core countries.
The decision on OMT was necessary. It was effective. And it was in line with our mandate.
It was necessary to remove severe obstacles to the appropriate transmission of monetary policy that were putting the singleness of our monetary policy at risk and which were harming the economy of the euro area very deeply.
And it is fully in line with our mandate because it is designed to preserve price stability for the euro area and uses instruments foreseen in the Statute.
In short, for the ECB responsible leadership has meant being true to our founding Treaty. Staying independent from the voices calling for us to “do more” or to “do less”; staying fully focused on our mandate to secure price stability for the citizens of the euro area.
For the euro area to now move forward and establish itself on stronger ground, we need all decision-makers to take their responsibilities. Governments to put right their public finances and address the structural challenges to growth in their economies; and the euro area as a whole to build a stronger economic and monetary union based on shared sovereignty and greater legitimacy.
There is a great deal of work ahead of us. But I am sure we will succeed.
Thank you for your attention.
Speech by Yves Mersch, Member of the Executive Board of the ECB,
at the Nordea 3rd Annual Nordic AAA Seminar,
Copenhagen, 13 June 2013
Ladies and Gentlemen,
It’s a great pleasure to speak to you at this 3rd Annual Nordic AAA Seminar.
Today’s seminar will examine the AAA fixed-income market, considering both the investor and the issuer perspective. It is clear that we as central bankers are closely watching these markets as they are of crucial importance.
Take, for instance, the working of monetary policy transmission. The impact of central bank action on the term structure of ‘risk-free’ rates is the backbone for the wider transmission of our monetary policy stance to a broad range of asset prices, to real activity and eventually to price developments. The price level is the ultimate objective of our mandate defined by the Treaty on the Union level which therefore can only be challenged by the European Court of Justice or a Treaty change.
Moreover, high-rated sovereign debt also plays a key role in our collateral framework and for the implementation of monetary policy. And finally, the yields on AAA-rated sovereign bonds provide central bankers with a rich set of information about the market’s outlook for inflation or future interest rates.
The recent years of crisis have provided two important lessons on sovereign debt markets. First, for sovereign issuers, an AAA rating is not working like an automatic life-time subscription. It must rather be interpreted as an award that requires healthy public finances and sound economic fundamentals in order to keep it. And second, both financial stability and monetary policy transmission could be at risk if the smooth functioning of sovereign debt markets is hampered.
In my remarks, I will address three issues from a euro area perspective:
- First, I will give you a summary of the current economic environment in the euro area and the outlook for economic activity and inflation.
- Second, I will elaborate on our latest monetary policy decisions.
- And third, I will address some of the specific questions for our monetary policy. That is on the one hand, the challenges close to the zero lower bound in an environment of slowly receding financial sector fragmentation and very low interest rates. And on the other hand, the challenges arising from keeping interest rates low for too long. But be aware that there is no forward guidance in any of my remarks that would provoke undue volatility.
The currently low inflation environment certainly warrants an accommodative monetary policy stance to improve credit conditions in the economy. But we are not the only player in this game. Engineering a broad based recovery and returning to sustained growth in the euro area can only be based on the appropriate structural policy efforts.
Subdued price pressure over the medium term, economic activity expected to stabilise slowly
Let me start with the current economic conditions in the euro area which show a combination of subdued underlying price pressure, a shallow recovery of economic activity and weak credit dynamics.
In the euro area, the output has continued to shrink in the first quarter of the year, so that we have now witnessed a decrease in gross domestic product (GDP) output for the sixth quarter in a row. Confirming this bleak picture, the unemployment rate has stayed in double digit territory.
On a somewhat more positive note, economic sentiment appears to be slowly picking up from low levels. Looking ahead until the end of next year, the Governing Council expects euro area export growth to benefit from the recovery in global demand.
Turning to price developments, euro area headline inflation stood at 1.4 percent in May. Our definition of price stability is a positive inflation rate below 2 percent. As capacity utilisation is low and the economic recovery is expected to be slow, we expect price pressure to remain subdued. Inflation expectations are well anchored.
Finally, the dynamics of loans to the private sector is still very feeble in the euro area.
The weakness in current and expected economic activity is certainly an important factor in depressing loan dynamics to the private sector in the euro area economy. The need for deleveraging for several banks, corporations and households is further dragging on growth dynamics. On top of that some borrowers are still facing elevated costs of financing, which also differ strongly across the euro area. While fragmentation on the funding side has receded, this cannot be said of lending activity to the real economy.
Focusing on euro area banks’ lending policies – the supply side of loans – credit risk and macroeconomic uncertainty remain their main concerns, according to the last wave of our Bank Lending Survey in April. In addition, the need for further balance sheet adjustment across sectors has certainly contributed to the slow pace in the provision of loans.
Euro area monetary policy remains accommodative
What I just described was a sketch of the situation which we saw in the ECB’s Governing Council last Thursday: On this basis, we decided that our monetary policy stance should remain accommodative as long as necessary and we kept interest rates unchanged.
Beyond this decision on rates, there is an on-going debate on further measures the ECB could take, if necessary, to provide additional accommodation or improve funding conditions, although, as I mentioned, fragmentation on the funding side is of lesser concern than on the lending side.
This debate has taken a broad scope, including for instance: measures to revitalise the market for Asset Backed Securities; additional long-term refinancing operations; enhancing the framework for additional credit claims; and broader or targeted changes in collateral policies. All these limited measures are under study or theoretically available on the shelf.
It is in this context, that also the issue of setting a negative rate on the deposit facility has come up. Speaking here in Denmark today, I would like to say a few more words on our decision on the level of that deposit facility rate.
Some commentators wondered whether we would consider taking this rate to negative territory, and many of those drew comparisons to the Danish case, where the central bank had decreased the rate on certificates of deposits to minus 20 basis points in July 2012.
The possibly negative deposit rate is one facet of the so-called “Zero Lower Bound” debate. While this concept enjoyed some prominence in the academic literature for several years, it seems to have now spread into something routinely discussed in taxi-drive small talks.
At first sight, the term “Zero Lower Bound” seems to provide for an unambiguous metric: once the relevant monetary policy rate is zero, it cannot fall any further.
One reasoning behind this is that any type of nominal interest rate cannot fall below zero. Anybody holding an asset with such negative remuneration would simply switch to cash. Then he would ‘at least’ earn a nominal return of zero.
However, this reasoning may be incomplete. One example is the case of negative deposit certificate rates at the Danish central bank that I already mentioned.
So obviously, under certain circumstances, some assets provide particular services that make market participants willing to hold these assets although they display negative interest rates.
To understand the nature of the question on possible negative deposit rates in the euro area, let me quickly recall that the ECB operates a corridor system consisting of three rates.
First, the main refinancing rate is the interest the ECB charges in the main refinancing operations with its counterparties. It usually provides the mid-point of the corridor system. Second, the marginal lending rate is the interest charged on overnight lending from the Eurosystem to banks. It constitutes the ceiling of the corridor system. Third, the deposit facility rate governs the remuneration for excess reserves that our counterparties hold with the Eurosystem as overnight deposits. It constitutes the floor to the corridor system. Moreover, it also provides the floor on interbank market rates as banks have no incentive to lend funds below this rate in the market.
Setting the deposit rate to a value below zero would imply that the remuneration for excess reserves in the euro area is negative. In other words, banks are charged for making overnight deposits with the ECB.
From a technical point of view, we are ready to implement a negative deposit facility rate. And, in general, there are constellations conceivable where the Eurosystem could deploy such a negative rate, if it is deemed required by our mandate to safeguard price stability.
So what are the pros and cons?
Theoretically, a negative deposit rate may provide additional accommodation. In the current environment of excess liquidity, the relevant overnight interest rates have shifted close to the deposit rate. In this situation, reductions in the deposit rate could push down overnight interest rates further.
At the same time, possible caveats and unintended side effects of this move have to be kept in mind. In particular, crossing the zero line can set off actions in the market that may run counter to the central bank’s policy easing intentions. For example, there can be a substitution by private actors towards cash which becomes the highest yielding short-term asset. Similarly, the money-holding sector may promote financial innovations that could emulate currency and allow tax avoidance. These actions may undermine the underlying purpose of the move towards negative deposit rates.
Overall, the consequences are subject to considerable margins of uncertainty as such a move has never been observed in the Eurosystem or in any other major currency area in the world.
How do these considerations differ from those underlying the move by Denmark’s or the Swiss central bank?
Both countries apply a fixed exchange rate policy vis-à-vis the euro area. In contrast, the ECB does not consider the euro exchange rate as a policy target. This adds an additional complexity to the monetary policy objective function.
What could be the effects of introducing a negative deposit facility rate on the euro exchange rate? One can in principle single out three factors that would be at work. First, the traditional interest rate differential channel could exert a downward pressure on the euro. Second, a signalling effect may amplify this downward pressure, as market participants would see a realisation of a completely new scenario, which they had previously priced in as a mere possibility. At the same time, an improvement of macroeconomic prospects – the very intention of that policy move in the first place – would possibly exert upward pressure on the exchange rate.
Overall, also for the exchange rate, any gauge of the impact of a move to a negative deposit facility rate might be subject to considerable uncertainty. Also the historical experience is of limited help: the few instances of such policy movements happened under different economic constellations and for central banks that worked under different monetary policy paradigms.
So, in conclusion, we are in a situation of a professional golfer who has a huge set of specialised clubs at his disposal - and he is in principle able to master them all. He will then draw the most suitable one depending on the position of the ball and the landscape he is facing. That is, negative rates are in our bag of tools, but may or may not be deployed depending on the economic landscape. This applies to all other tools and measures that I mentioned before as well.
In this context, our monetary policy strategy provides the necessary flexibility to react to different economic and market constellations. This flexibility derives from our medium-term policy horizon and the definition of price stability. It is defined not as a point target but as a range of permissible inflation outcomes. These two elements of flexibility ensure that we do not have to mechanically react to temporary shifts of prices. Instead, we can adopt a steady hand approach. This avoids policy-induced volatility.
Challenges to monetary policy in an environment of fragmentation and the implications of protractedly low interest rates
This brings me to my third and last part: where do we stand and what are the challenges that we are facing in the euro area?
Since the outset of the financial crisis in 2007, we had to adjust and expand our toolkit in order to be optimally equipped in serving our objective of price stability amid evolving challenges.
The biggest challenge that we saw during the last year, I would summarize that with the term ‘fragmentation’.
What is behind this? Recall that our objective is to safeguard price stability for the euro area as a whole. However, fragmentation in financing conditions means that for two firms with the same credit risk, the financing conditions would depend on the area of residence. The same holds for private households. As a result, our monetary policy stance is not transmitted homogeneously in all parts of the euro area. In other words, before the crisis, an interest rate cut of 25 basis points was passed through to bond yields, bank deposit rates and lending rates in a similar fashion throughout the euro area. Now, this pass-through has become smaller on average and its effect very disparate across jurisdictions.
One of the main factors contributing to fragmentation was the increasingly perceived risk that the euro area might break up and some countries would return to a domestic currency – the so-called redenomination risk. Such fears manifested themselves as undue and sizeable spread surcharges in sovereign bond yields. But it also affected all sorts of other financial asset prices, such as corporate bond yields and other financing rates, through various contagion channels.
So if ‘fragmentation’ is the one word characterizing the main threat to our stability-oriented monetary policy, one of our most successful answers to it can be summarized in only three letters: OMT. This stands for the programme of Outright Monetary Transactions. OMT keeps up all motivation of the respective countries for consolidation and the necessary structural reforms. This ‘incentive-preserving’ feature of OMT results from the implied conditionality as well as from the fact that after the removal of the excessive ‘panic’ component of bond yield spreads, capital markets can exert their disciplining function via sovereign debt pricing.
Finally, although not a single Euro has been spent on OMT yet, the programme has been highly successful already. Let me give you a few examples, where the OMT announcement has certainly contributed to positive developments, while - of course - it cannot be singled out as the sole responsible factor:
Sovereign bond spreads for stressed jurisdictions came down from the excessive levels observed in summer 2012; sovereign bond yields in core countries also normalised by moving upwards reflecting a reversal of previously extreme flight-to-safety flows; bank deposits have been slowly flowing into peripheral countries; banks’ recourse to Eurosystem financing has decreased; corporate bond spreads and financial market volatility has come down; and TARGET balances – the aggregate gross claims of national central banks against the Eurosystem – have also decreased.
While this improvement is certainly welcome, we are facing two challenges: first, significant fragmentation – while mitigated – remains. Second, we must be wary of the potential side effects of our monetary policy.
In fact, the partial relaxation in financial markets, which I mentioned, has already induced some commentators to ventilate the idea that we may face renewed exaggerations – not unlike the underpricing of risk that we have seen before the crisis in some market segments. Some even assert that the protracted period of low interest rates could by itself be a factor to trigger such distortions.
In fact, a low-interest-rate environment may in principle spur an underpricing of certain risks, support the emergence of asset price bubbles, or provide incentives to delay certain adjustments in bank balance sheets with the risk of zombie-banking and evergreening.
However, in the euro area we do not see evidence of broad-based mis-alignments in asset prices. As a case in point, common valuation metrics of major stock price valuation levels are near their historical averages - rather than exaggerated as was the case in earlier low-rate periods.
At the same time, there is no reason for complacency, and a future build-up of imbalances in certain market segments cannot be excluded. But this is exactly the field where macroprudential authorities have to be alert and intervene with market-specific instruments. So, let me repeat in this context my appreciation for the micro- and macroprudential policies at EU and national level that are underway.
Regarding the required balance sheet adjustments the benign market environment should rather be a supportive factor for that. Decent stock market valuation levels, for instance, tend to decrease the cost of capital. That’s helpful for re-capitalisation. Moreover, banks’ balance sheets will be scrutinized upon transition to the Single Supervisory Mechanism – once the required backstop for possible recapitalisation needs will be in place.
In any case, the level of our policy rate has to be always understood as reflecting our best attempt of safeguarding price stability in the euro area as a whole. I think, in this respect, the single objective is a very important guide post to anchor inflation expectations, but also to make transparent and traceable the trajectory of our rate setting.
Conclusion and outlook
Let me conclude. Almost six years after the outbreak of the financial crisis in summer 2007 the economic situation in the euro area is far from back to normal. Unemployment is high in several member states, growth is expected to return only gradually and credit to the real economy is reaching the real economy fairly reluctantly overall and at different speed levels across euro area countries. Following its objective of safeguarding price stability, the ECB had to activate a variety of non-standard measures to improve the transmission of its accommodative monetary policy stance. However, we are still operating in a difficult environment and fragmentation of financing conditions across the euro area is one of the most prevalent problems.
So let me finish with some key messages that, I think, characterise the policy landscape in the time to come:
- Monetary policy has helped to prevent economic outcomes to be even worse than what we see today. Monetary policy accommodation is needed to keep prices in line with the ECB’s definition of price stability.
- The ECB has not run out of ammunition. We can employ more tools and measures whenever they will be needed.
- But monetary policy has limits: it is not effective when it comes to structural issues and we should keep in mind the challenges that arise from keeping interest rates too low for too long. Therefore we should not forget about the responsibilities of other policy areas:
- A properly designed banking union is essential to restore financial integration and to support a new steady state where bank balance sheets will be fit for lending
- Fiscal consolidation is required to spur and maintain confidence of consumers and investors
- Structural reforms are key to bring euro area economies back on a sustainable growth path.
For the ECB, the different crisis modes required various modifications in our tool box of monetary policy instruments. But our objective of price stability remained time-invariant. It has served as an anchor of stability in the euro area during the crisis; it is helping the transition to a new steady state of a better-integrated euro area economy; and it will certainly remain our guiding principle in the future.
Thank you for your attention.
Speech by Jörg Asmussen, Member of the Executive Board of the ECB,
at the General Assembly of the European Savings Banks Group,
Berlin, 14 June 2013
Gentlemen,
Thank you for inviting me to speak today.
Let me start by reviewing briefly the overall economic situation in the euro area. We are currently projecting a gradual recovery in economic activity, with the economy expected to stabilise this year and then grow by 1.1 per cent in 2014.
Underpinning this outlook are, first, receding tensions in financial markets, notably the disappearance of the debate about the reversibility of the euro. And second, a more robust global recovery, mostly fuelled by emerging markets, but also by promising signs from across the Atlantic.
Our projections for inflation show an increase of prices of 1.4 per cent in this year and 1.3 per cent next year. Most importantly, inflation expectations as securely anchored. Hence, we see no upside risks to price stability at the moment.
However, this overall picture conceals considerable divergence within the euro area. This is visible in the very different economic and employment situation between Member States, but also – as you know well – in financial market conditions. Financial markets are still showing a considerable degree of fragmentation creating very heterogeneous financing conditions across the euro area.
This means that, as savings banks from across Europe, you will probably have quite different concerns. For some, I expect the main concern is constrained access to funding and too high interest rates. For others, it may be excess liquidity and too low interest rates. And both sets of concerns are valid: tight money is constraining growth in peripheral countries, while easy money could eventually pose long-term risks in core ones.
I therefore want to focus my remarks today on how we can deal with this problem of financial fragmentation, because it is a key issue in all parts of the euro area. I would like to approach the topic from three angles:
First, the role of governments.
Second, the role of the ECB.
Third, the role of Banking Union.
1. Dealing with financial fragmentation: the role of governments
I begin with the role of governments because it is important to stress that they have the first responsibility for dealing for financial fragmentation. While there is much media focus on ECB actions and Banking Union, it is only really governments that can deal with the root causes of the current situation.
There are three channels where this is particularly relevant.
First, one cause of financial fragmentation is the high public debt levels in some euro area countries, which, as domestic banks are heavily exposed to their own governments, harms banks’ asset quality. In Italy, for instance, 65% of bonds were held domestically in early 2012, and in Spain 70%. Clearly, governments have a central role in dealing with this problem by ensuring that their debt is safe and sustainable. This requires credible fiscal consolidation.
Second, another cause of fragmentation is low growth, which deters banks from taking risk, especially lending to SMEs. Interest rate spreads on SME loans compared with those for large non-financial companies have widened by an average of 40 basis points since 2010. A key part of the solution here has to be structural reforms that improve the medium-term growth outlook and hence support risk appetite. Only governments can introduce them.
Third, fragmentation is also caused by weak bank balance sheets. Lack of capital, weak profitability or rising non-performing loans lead to lower credit provision or higher interest rates being charged on new loans to offset losses elsewhere. But it is governments that have to deal with this problem through recapitalisation and restructuring.
In other words, without actions from governments, we will not be able to reintegrate financial markets.
Fortunately, positive progress is being made. The Commission projects the euro area fiscal deficit to fall below 3% of GDP this year – less than half the peak reached in 2009. Under pressure from supervisors, euro area large and complex banking groups have continued to improve their capital positions, with the median core Tier 1 ratio reaching 11.1% in the first quarter of 2013, up from 9.6% at the end of 2011.
But there is still a long way to go before the “singleness” of the euro area financial market is restored. This means that there is no room for complacency for governments.
Most of all, they should not expect the ECB to substitute for actions that they must take themselves.
2. Dealing with financial fragmentation: the role of the ECB
What is then the role of the ECB in addressing financial fragmentation?
The ECB necessarily operates within certain constraints. We are the European Central Bank, and so our focus is the euro area as a whole, not the concerns of any particular country. And we can only address issues that fall within our mandate to maintain price stability.
Within these constraints, we have acted to reduce financial fragmentation in two key ways.
First, we have taken measures to reduce divergence between countries caused by bank funding risk.
We have provided unlimited liquidity to banks in need at fixed interest rates, extending the maturity of our operations up to 3 years. We have allowed national central banks to tailor collateral rules to national conditions. And we have narrowed the interest rate corridor between the deposit rate and our main policy rate to 50 basis points, which reduces cross-country heterogeneity in funding costs. All this was designed to support the transmission of our low interest rates more evenly across the euro area.
Second, we have taken measures to remove fragmentation caused by redenomination risk.
This risk was affecting some countries more than others as markets feared that, if one country were to leave the euro area, a domino effect would force certain others to leave as well. According to calculations, the redenomination premium being paid by Spain and Italy in July 2012 was up to 2%. And the threat this posed for future price stability was evident in the cost of deflation protection in the euro area: this rose from 198 bps in January 2012 to a peak of 270 bps in July that year.
Our answer to this was the Outright Monetary Transactions (OMT) programme. Its effects have so far been powerful, not only in reducing sovereign spreads, but also in improving funding conditions for corporations, banks and individuals across the euro area. Financial fragmentation has been reduced, as shown by the best summary indicator, the level of Target2 balances. They have declined by 285 billion euros, or 25%, since the peak last year.
It is important to stress, however, that the benefits of lower financial fragmentation are not only being felt in struggling countries. I am aware that some of you here are concerned by the current low interest rate environment, as it reduces income for savers and squeezes returns for pension funds and insurance companies. Moreover, some are rightly worried that interest rates that are too low for too long could lead to misallocation of resources and reduce incentives for governments, banks, and corporates to adjust.
It is therefore worthwhile to note that the overall improvement of the situation has led to an increase in German government bond yields, which have gone up by around 25 basis points since the announcement of the OMT. This demonstrates that the more ECB actions help normalise the financial situation in the euro area, the higher these and other interest rates will eventually rise. This is why we have always said that OMT is a policy not for one or another group of countries, but for the euro area as a whole, in line with our mandate.
Indeed, there will always be some that want the ECB to “do more” and others that want us to “do less”. I just attended as an expert the hearing of the German Constitutional Court, where those who brought the case to the constitutional court find the ECB has already done too much. But our answer, all along, has been consistent: we have done, and will continue do, what is necessary to preserve price stability within our mandate.
3. Dealing with financial fragmentation: the role of Banking Union
While the actions I have described by governments and the ECB have helped to combat financial fragmentation, there is no doubt that a third factor is also key: building a deep and genuine Banking Union.
The term Banking Union encompasses a number of regulatory initiatives, but it really has two key elements: a Single Supervisory Mechanism (SSM) and a Single Resolution Mechanism (SRM). These are complements and progress on both in parallel is essential.
As regards the SSM, close cooperation has now been established between the ECB and the National Competent Authorities (NCA) and preparatory work is well underway. Among other things, this work includes developing a common supervisory approach and preparing for the comprehensive assessment of all banks that will come under direct ECB supervision, as demanded by the SSM Regulation.
Let me say a few words on these two issues.
The creation of a common supervisory approach is essential to ensure that the overall system plays by a single set of rules. But it will not greatly affect day-to-day supervision for savings banks such as most of yours. This will still be carried out by local supervisors who understand the specificities and needs of smaller institutions. The SSM is not being created to interfere where local supervision functions well, but to ensure that there are no “blindspots” from which financial instability could emerge – as the crisis has shown, we cannot afford for even smaller banks to be completely off the radar.
The comprehensive assessment of banks under direct ECB supervision will involve an Asset Quality Review and Balance Sheet Assessment to be conducted by the ECB in the first quarter of 2014. This will then feed into the overall stress test to be conducted by EBA, in cooperation with the ECB, in the second quarter of 2014. This assessment is essential to ensure that the SSM starts with a clean slate and gain credibility in the market – we therefore want it to be as rigorous as possible.
How will these developments help financial fragmentation?
First, the creation of a common supervisory approach, together with uniform data reporting requirements, should reduce compliance costs for banks and encourage greater cross-border banking activity.
Second, the comprehensive assessment, if conducted to a high standard, should increase confidence in the overall health of the euro area banking sector. This is important to begin reintegrating the interbank and other bank funding markets.
But for these effects to be realised, it is essential that the SSM is accompanied by a credible SRM. Markets will only fully trust in SSM supervision if it is clear that banks can be safely wound down without damaging financial stability – otherwise they will expect supervisors to practice forbearance. Moreover, without a strong SRM bank funding costs will continue to be tied to fiscal situation of the sovereign, which will perpetuate financial fragmentation.
To deal with large and complex banking groups, we need an institution that can take swift, impartial decisions. To break the link with sovereigns, it needs to have sufficient resources to back those decisions up. This requires a single resolution authority and a single resolution fund, established at the European level. The first best option would be to entrust a newly established agency with this task. If this is not feasible in the short run, the ESM could be tasked with this for an interim period as a second best option.
Such a fund would be financed by ex ante risk-based levies on the banking sector, and in the build-up phase, any public support would be recouped by additional ex post levies on banks. This arrangement has two clear benefits: first, the financial sector itself would ultimately pay for the costs of financial crises, and second, less risky banks such as savings banks would pay-in less than institutions engaged in speculative activity.
An additional feature of the SRM, which may appeal to some in this audience, is that it to some extent reduces the need for moving towards a common deposit guarantee arrangements, at least in the medium-term. If banks can be safely wound down, and if there is a depositor preference rule that means that deposits are rarely bailed-in, then national deposit guarantee schemes should in most cases be sufficient.
Finally, let me say a word on direct bank recapitalisation by the ESM. There are various misconceptions about this instrument, such as that it opens up the possibility for debt mutualisation through the backdoor. That is absolutely not the case. Recapitalisation through the ESM will come only after, first, shareholders and creditors have been written down, and second, the beneficiary Member State has absorbed all incurred and expected losses based on a rigorous economic evaluation. So the prospect of losses for the ESM is limited.
4. Conclusion
Let me now conclude.
I have shown today that tackling fragmentation requires action of all fronts: from governments, from the ECB, and from the euro area as a whole through building Banking Union.
The challenge is now to build consensus behind such action, particularly Banking Union. And the case is clearly a strong one. For countries in difficulty, financial reintegration is essential to reduce interest rates for borrowers and restart growth. For those doing well, it is essential to raise interest rates for savers and prevent future distortions.
I therefore hope that you, as savings banks from across the euro area, will form a key part of this constituency.
Thank you for your attention.
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