Single market vs eurozone: financial stability and macro-prudential policies | The New Financial...

Single market vs eurozone: financial stability and macro-prudential policies

23 April 2015

The new financial architecture in the eurozone

European University Institute

N.B: The views expressed are the author’s and do not reflect those of the ECB.

Carmelo Salleo

ECB - DG MF/MAF

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www.ecb.europa.eu ©

Never let a good crisis go to waste *

The financial crisis which started in 2007 elicited 2 types

of responses:

•Conjunctural: fiscal, monetary, prudential policies were

put in place to mitigate the impact of the crisis and

rebound – with mixed results.

•Structural: policy makers devised a new analytical and

institutional framework for a comprehensive approach to

financial stability.

* Winston S. Churchill.

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Source: ECB, FED

3

Fiscal and monetary policies during the crisis

0%

2%

4%

6%

8%

10%

12%

2006 2007 2008 2009 2010 2011 2012 2013 2014expected

UK US EA

Source: Bloomberg

Unconventional Monetary Policy: Central bank’s balance sheet / GDP Monetary vs. Fiscal Policy: Government debt bought by central banks

Source: ECB, FED, BoE Source: ECB, FED, UK Debt Management Office

Fiscal Policy: Government budget deficit / GDP

0%

10%

20%

30%

40%

50%

2006 2007 2008 2009 2010 2011 2012 2013 2014

UK US EA

0%

40%

80%

120%

2006 2007 2008 2009 2010 2011 2012 2013 2014

UK US EA

-5

-4

-3

-2

-1

0

1

2

3

4

5

2006 2007 2008 2009 2010 2011 2012 2013 2014

UK US EA

Monetary Policy: Real interest rates

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Source: BIS

4

Credit and GDP during the crisis

Source: BIS, Eurostat, FED

Real GDP per capita (2006=100)

Source: Eurostat

Macro-Prudential Policy: Private sector credit to GDP Total (private sector+government) debt to GDP (YoY change)

95

96

97

98

99

100

101

102

103

104

105

2006 2007 2008 2009 2010 2011 2012 2013 2014

UK US EA

100%

120%

140%

160%

180%

200%

220%

240%

260%

2006 2007 2008 2009 2010 2011 2012 2013

UK US EA

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

2007 2008 2009 2010 2011 2012 2013 2014

UK US EA

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What did we learn from the policy mixes of

the past few years?

•In terms of the business cycle, given the severity of the shock

not surprisingly fiscal and monetary policy worked best when

they were pulling in the same direction.

• if the problem was debt overhang, it wasn’t solved. At most

there was a substitution of public for private sector debt.

•What role could there have been for macro-prudential

policies before and during the crisis?

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The new framework in the European Union - I

Much of the new framework was developed in Basel, then

implemented in the EU with the CRD IV/CRR. The main

elements are:

•To address pro-cyclicality: counter-cyclical capital buffers.

•To address too big to fail: SIFI buffers, CoCos, bail-in.

•To address contagion: capital buffers and sectoral

requirements, limits to large exposures.

•To address firesales: capital buffers and liquidity ratios.

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The new framework in the European Union - II

While the tools are common to all countries, the governance

is different between EA and other countries. EA countries

adhere to a banking union (others can join if they want), which

means:

•Common banking supervision (SSM).

•Common resolution (SRM).

•National central banks and the ECB share powers over

macro-prudential tools (but NCBs keep exclusive control of

tools not mentioned in the CRD IV/CRR, such as LTV and

LTD).

•In the future: common deposit insurance scheme.

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The new framework in the European Union - III

Each country in the EU chooses how to organise its financial

stability oversight:

•All responsibilities to the central bank (UK).

•Bank supervisors are also the macro-prudential authority

(Sweden).

•A council with the central bank, financial supervisors and the

Treasury (Denmark).

KEY DIFFERENCE BETWEEN THE EA AND OTHER EU

COUNTRIES: outside the EA policy makers can coordinate

effectively fiscal, monetary and prudential policies, while in the

SSM there is a single monetary policy while fiscal policies

remain at the national level and are difficult to coordinate

among themselves, let alone with the other policies.

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Real and financial relationships within the EU

UK

Euro Area 19: BE, DE, EE, IE, GR, ES, FR,

IT, CY, LV, LT, LU, MT, NL, AT, PT,

SI, SK, FI

CEE Non-EA:

BG, CZ, HR,

HU, PL, RO

1.4%

0.3%

54.5%

4.9%

18.1%

4.0% 75.1%

2.0%

51.2%

11.7%

Notes:

Full lines represent trade to GDP ratio (i.e. bilateral X+M /GDP)

Dashed lines represent claims by banks vis-à-vis other

EU regions as a % of total foreign claims (where available).

Source: UN Comtrade, BIS Consolidated International Banking Statistics.

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Challenges: the EA and CEE - I

• CEE countries have mostly pegged their currency to the

euro: their monetary policy is thus heavily influenced by

ECB decisions. This means limited possibilities to use

monetary policy as an independent instrument should their

business cycles diverge from the EA’s.

• Banking systems in the CEE are part-owned by EA banks.

This means a limited scope for independent prudential

policies should financial cycles diverge from the EA’s

(essentially, it depends on how banks manage a

consolidated balance sheet across subsidiaries).

• The only degree of freedom left is fiscal policy, which

already has its goals and limitations.

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Challenges: the EA and CEE - II

How likely is this going to be a problem?

•Business cycles are not too divergent, and the exchange rate

can be adjusted in most cases.

•Some countries are entering in “close cooperation” with the

SSM, i.e. they are joining the banking union and becoming “co-

home supervisors of their own banks”.

•The ESRB provides a forum to discuss and coordinate macro-

prudential policies.

•Being part of the EU ensures participating in the common

development of a Capital Markets Union and of further

integration of financial infrastructures.

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Challenges: the EA and the UK

• A flexible exchange rate means a more independent

monetary policy.

• Linkages are mostly due to cross-border flows and common

exposures.

• Coordination of prudential policies: from race to the bottom

to gold plating – both are competitive strategies.

What are the main issues?

• Coordination of macro-prudential policies: ESRB.

• Structural problem: the relationship between banks and

markets is different in the EA and the UK.

• Brexit – how would it change the balance with the EA?

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Conclusion: the EA within the single market

a financial stability perspective

• The key role of fiscal policy also for financial stability cannot

be ignored. Within the EA this calls for much greater

cooperation and coordination also in the fiscal dimension.

• Between the EA and CEE: the (semi-)fixed exchange rate

regime and strong presence of EA banks in the CEE make

the 2 regions very interdependent also from a financial

stability perspective. This calls for more integration of

prudential policies.

• Between the EA and the UK (and other EU non-CEE

countries?): the relationship seems sufficiently loose and

with enough degrees of freedom that differences in financial

cycles should have little spillovers.

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