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The (changing) role of central banks in financial stability policies




Speech by Peter Praet, Member of the Executive Board of the ECB,
at the 14th Annual Internal Banking Conference,
organised by the Federal Reserve Bank of Chicago and the European Central Bank, Chicago

More than four years have passed since the onset of the financial crisis. Over these years, central banking functions have been stretched to the limits.
Recent developments demonstrate how fragile our financial system remains, not only because of debt legacy but more worrisome because of its mere design.
The public debt crisis in a number of advanced economies is also raising fundamental questions about the role of public debt instruments in our financial system.
Looking backwards, one can say that disciplining mechanisms in debt markets have clearly failed, often as a result of mutually reinforcing market and government failures. Too much debt in the public sector is the symptom of both ineffective public governance and market discipline. Budget rules, such as the no-bail-out provision of the Maastricht Treaty, didn’t contain the accumulation of debt. In the banking sector, the disciplining role of sight-deposits has proven to be time-inconsistent in the presence of the negative externalities that the failure of a large institution would create. Although the role of monetary policy in the build up of the crisis is still debated, it does influence in an important way the price of leverage. [1]
Lack of attention and preparedness to tail-events has been particularly striking. While central banks have always paid attention to the possibility of extreme events in payments and post-trade infrastructures, too little efforts have been devoted to the prevention of the conditions under which emergency liquidity assistance would be provided to the financial sector. Other authorities were concerned, such as supervisors at the micro-level and ministries of finance. The necessity of constructive “ambiguity” was also invoked to keep a low profile.
Achieving and preserving financial stability has now become a key policy objective in our societies. Building up separate macroprudential policy functions is considered one of the main elements of the wide ranging policy reforms in pursuit of this objective. The idea is to entrust the authority in charge of macroprudential policy with the task of monitoring, identifying and mitigating systemic risks as they emerge. Macroprudential policy, by taking a system-wide perspective, thereby complements microprudential policy which is mainly oriented towards ensuring the health of individual institutions or markets. But the way to organise the macroprudential function is still work in progress in particular on the role of central banks. There are different views on how to design such a framework and how they should relate to central banks, their governance structures and their monetary policy strategies. [2] This is essentially related not only to the difficulty to define financial stability in an operational way (contrary to price stability), but also to the number of authorities concerned (central banks, bank supervisors, insurance supervisors, market supervisors, competition authorities, consumer protection authorities, Ministries of Finance, Ministry of Justice, resolution authorities) and to the variety of possible tools often assigned to several objectives.
Central banks should undoubtedly assume important roles in macroprudential policies. Central banks bring in essential expertise in analysing financial systems from an aggregate perspective. They also have proper incentives to mitigate systemic risk ex ante since central banks typically have to deal with the fallout from financial crises. Last but not least, involving central banks in macroprudential policy should foster effective coordination between monetary policy and financial stability policies in a manner that preserves their autonomy. Policy coordination is likely to become important in light of the strong mutual interdependencies between the financial and the real sectors and thereby between both policy functions. I will come back to policy coordination later on.
A wide range of different approaches exist to institutionalise central banks’ role in the new financial stability frameworks. The different approaches taken largely respond to country-specific circumstances. A “one size fits all” approach simply doesn’t exist. This is also in the European Union where individual countries have adopted different approaches.
At the level of the European Union as a whole, a new financial supervisory architecture became operational at the beginning of 2011. It includes three new European supervisory authorities (ESAs) for banking, insurance and securities markets – which aim to strengthen micro-prudential supervision – and the European Systemic Risk Board (ESRB) responsible for macroprudential oversight. The ECB ensures the Secretariat function for the ESRB – without prejudice to the principle of central bank independence -, and is also in charge of providing analytical, statistical, administrative and logistical support to this new EU body. Moreover, central bankers hold the majority in the ESRB’s decision-making body, the General Board. [3] The main tasks of the ESRB are to monitor and assess systemic risk and to issue warnings and, where necessary, recommendations to the relevant policy-makers which are not legally binding but depend on the principle of “comply or explain”.
However, the ECB’s contribution to achieving and maintaining financial stability does not rely exclusively on its responsibilities for an effective functioning of the ESRB. Obviously, the way the ECB conducts monetary policy also impacts on financial stability. Some people call for vast changes in central banks’ institutional setup and their monetary policy strategies with a view to pursue price stability and financial stability as coequal objectives. In my view, by contrast, major changes in the institutional and strategic framework of monetary policy are not necessary. But business as usual in central banking will not do it either.
Business as usual would imply adhering to what has become known as the “Jackson Hole consensus”. According to this pre-crisis consensus view, central banks should only respond to asset prices and financial imbalances to the extent that they affect the shorter term inflation forecast. [4] If financial imbalances still emerged, central banks should follow a “mop up” or “cleaning” strategy after the burst of the bubble. Maintaining price stability is simply the best central banks could do to contribute to financial stability.
This view implied a strict separation between monetary policy and financial stability policy. Central banks had been well aware of the importance of financial stability for the smooth conduct of monetary policy and of their varied responsibilities in ensuring financial stability on the other hand. Yet, the importance of the possible implications of financial imbalances were underestimated and not systematically integrated in the analytical apparatus supporting monetary policy. This flaw in the intellectual underpinning misled central banks to downplay their financial stability functions and supported the general view that monetary and microprudential policy can be conducted separately, with monetary policy instruments geared towards achieving macroeconomic stability, and financial regulation and supervision aimed at preserving financial stability in the spirit of Tinbergen’s policy assignment rule. [5]
However, it has become clear by now that this strictly dichotomous view is flawed since monetary policy and financial stability policy are intrinsically linked to each other, given the powerful interactions between financial and economic conditions. As the recent crisis forcefully demonstrated, the previous mainly microprudential orientation of financial regulation and supervision proved unable to curb the tendency of the ever more complex and opaque financial system to generate excessive amounts of systemic risk. The unravelling of the associated financial imbalances brought about the biggest financial and economic disaster since WWII which, in turn, severely impacted on the conduct of monetary policy. As the monetary policy transmission mechanisms were affected, central banks had to take unconventional measures.
The crisis also taught us that “cleaning” rather than “leaning” against financial imbalances can simply become too costly to be ignored ex ante. In addition, we also learned not to underestimate the moral hazard associated with the asymmetry in the previous consensus view of monetary policy.
In the light of the obvious breakdown of the Jackson Hole consensus, the view has become more popular that under certain circumstances, central banks may be well advised to actively lean against the emergence of financial imbalances in order to mitigate systemic risk and the associated longer term risks to price stability and economic welfare. [6]
At the ECB, we have always emphasised one tool which helps us maintain a medium to long-run orientation: the “monetary analysis”. The monetary analysis is one element of the ECB’s two-pillar framework – in addition to the economic analysis – for the regular assessment of risks to price stability. But we have always foreseen that monitoring monetary and credit developments is also part of an overall framework for addressing asset price misalignments. The analysis of low-frequency trends in money and credit developments has always been associated with the emergence of imbalances, because it allows us to assess risks to price stability well beyond the typical shorter term forecast horizons.
This notwithstanding, for what concerns the monetary policy strategy, significant efforts are still to be undertaken in building up an appropriate analytical framework linking the various sources of systemic risk to economic outcomes over long policy horizons. This may robustify the ECB’s two-pillar monetary policy strategy to better cope with risks of highly uncertain, low probability but very costly events such as financial crises.
A better understanding of the transmission channels that exist between the financial and the real sectors is therefore of the essence. While some headway has been made in studying non-conventional transmissions channels such as the risk-taking channel, other issues still remain work in progress. [7] For example what is the influence of interest rates on risk tolerance? What is the interrelation between funding and market liquidity? What are the determinants of the leverage cycle, and which role is played by financial innovation? Given the complexity of the issues involved one has to admit that the development of an operational framework linking monetary policy to the various forms of systemic risk is extremely complicated and poses severe intellectual challenges.
Financial stability risks may also arise from excessive monetary policy activism geared toward buying insurance against adverse macroeconomic and/or financial stability conditions. For instance, central banks might threaten future economic and financial stability if they keep policy rates too low for too long in the aftermath of a crisis. [8] In the context of the present crisis, the risk of missing the right time to exit from unconventional monetary policy measures offers a case in point.
In the light of these insights, it should be clear that monetary policy cannot do it alone. Financial stability should mainly be pursued by microprudential and macroprudential policies [9].
Also, in order to achieve price and financial stability a pairing of appropriate policies by all relevant authorities is indispensable. One avenue might be to give an agent the specific mandate to assess the financial stability impact of regulatory and tax changes when relevant.
However, policy coordination is in general not easy. Coordination might be impaired by problems of time inconsistency when the objective functions of the authorities involved may differ. For instance, governments may succumb to the temptation to respond to electoral pressures or lobbying activities from the financial industry. A macroprudential authority might also be endowed with too much discretion in its instrument setting. These potential policy failures may therefore favour a more rules-based approach towards the macroprudential policy. This applies both to policy tools addressing the time dimension of financial stability (like counter-cyclical capital requirements or loan-to-value ratios) and tools relating to the cross-section dimension (like surcharges for SIFIs, leverage ratios, bank merger and acquisition policy, limits to business organisation, etc.). As the financial system is highly adaptive one has to be aware that only controlling the time dimension of financial stability is not sufficient. For example, similar rates of asset price inflation in the real estate markets may not imply similar risks to financial stability even when occurring at similar points in the financial cycle. A proper assessment of systemic risk always requires a thorough analysis of borrower and lender fragilities as well as of the whole intermediation process.
Policy coordination is also particularly challenging in a currency union when credit cycles (eg. real estate cycle) are not synchronized. Moreover, monetary integration in the European Monetary Union has advanced at a much higher pace than the integration of financial stability and fiscal policies. An important step forward was allowing the ESRB to make country-specific recommendations but a further strengthening of its powers might still be needed.
To conclude, challenges are immense both on the technical side as well as on the governance side to safeguard financial stability. In essence, the task consists in reinforcing disciplining mechanisms in private and public debt markets. There is a need to act in a number of areas. Central banks have an important role to play as coordinator/ facilitator/ initiator. They also have the proper incentives to do so in order not to overburden monetary policy.

[1]See Adrain, T. and H.S. Shin (2011), “Financial intermediaries and monetary economics”, in: B. M. Friedman and M. Woodford (eds.), Handbook of Monetary Economics, Vol. 3A, Elsevier.
[2]See Nier, E., J. Osinkski, L.I. Jacome and P. Madrid (2011), “Institutional models for macroprudential policy”, IMF Staff Discussion Note, SDN/11/18, November and also Eichengreen, B. et al. (2011): “Rethinking central banking”, Committee on International Economic Policy and Reform, September.
[3]The General Board consists of the following members with voting rights: the President and the Vice-President of the European Central Bank (ECB); the Governors of the national central banks of the Member States; one member of the European Commission; the Chairperson of the European Banking Authority (EBA); the Chairperson of the European Insurance and Occupational Pensions Authority (EIOPA); the Chairperson of the European Securities and Markets Authority (ESMA); the Chair and the two Vice-Chairs of the Advisory Scientific Committee (ASC) of the ESRB; the Chair of the Advisory Technical Committee (ATC) of the ESRB; and the following members without voting rights: one high-level representative per Member State of the competent national supervisory authorities (the respective high-level representatives shall rotate depending on the item discussed, unless the national supervisory authorities of a particular member State have agreed on a common representative), and the President of the Economic and Financial Committee (EFC) of the Ecofin, which is the only representative of finance ministries.
[4]See, for example, Bernanke and Gertler (1995) and the response by Cecchetti et al (2000).
[5]See F. S. Mishkin (2010): “Monetary policy strategy: Lessons from the crisis”, Paper presented at the ECB Central Banking Conference, “Monetary policy revisited: Lessons from the crisis”, Frankfurt, November 18-19.
[6]See, for example, Borio, C. (2011): “Central banking post-crisis: What compass for unchartered waters?”, BIS Working Paper No. 353, September.
[7]For a recent overview see Adrain, T. and H.S. Shin (2011), “Financial intermediaries and monetary economics”, in: B. M. Friedman and M. Woodford (eds.), Handbook of Monetary Economics, Vol. 3A, Elsevier.
[8]See, for instance, Maddaloni, A. and Jose-Luis Peydro (2011), “Bank risk-taking, securitisation, supervision, and low interest rates: Evidence from the Euro-area and the U.S. lending standards”, Review of Financial Studies, Vol. 24, No. 6.
[9]In fact, such a division of labour receives support from latest research conducted within the Macroprudential Research (MaRS) network of the European System of Central Banks. Under most circumstances it turns out that financial imbalances are better addressed by macroprudential policy measures (e.g., counter-cyclical loan-to-value ratios) rather than by a monetary policy “leaning against the wind”. See Beau, D., L. Clerc, and B. Mojon (2011): “Macro-prudential policy and the conduct of monetary policy”, Banque De France, Occasional Papers No. 8, and Lambertini, L., C. Mendicino, and M. T. Punzi (2011): “Leaning against boom-bust cycles in credit and housing prices”, Banco de Portugal, Working Paper 8/11.
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Take on more risk or taper? BOJ faces tough choice with REIT buying



Take on more risk or taper? BOJ faces tough choice with REIT buying 1

By Kentaro Sugiyama and Leika Kihara

TOKYO (Reuters) – The Bank of Japan (BOJ) is under pressure to relax rules for its purchases of real-estate investment trusts (REITs) so that it can keep buying the asset at the current pace, highlighting the challenges of sustaining its massive stimulus programme.

The fate of the rules, which limit the central bank’s ownership of individual REITs to a maximum of 10%, could be discussed at the BOJ’s review of policy tools at its March 18-19 meeting, with an industry estimate putting nearly a third of its REIT holdings at close to the permissible threshold.

Given Japan’s fairly small REIT market, the BOJ may struggle to keep buying the asset unless it relaxes the ownership rule or accepts REITs with lower credit ratings, analysts say. The BOJ currently buys REITs with ratings of AA or higher.

“There’s a good chance the BOJ could tweak the rules for its REIT buying at the March review,” said Koji Ishizaki, senior credit analyst at Mizuho Securities.

The issue underscores the tricky balance the BOJ faces at the March review, where it hopes to slow risky asset purchases without stoking fears of a full-fledged withdrawal of stimulus aimed at weathering the prolonged battle with COVID-19.

As part of its stimulus programme, the BOJ buys huge amounts of assets such as exchange-traded funds and J-REITs.

It ramped up buying last March to calm markets jolted by the pandemic, and now pledges to buy at an annual pace of up to 180 billion yen ($1.68 billion).

The BOJ last year bought 114.5 billion yen worth of J-REITs, double the amount in 2019, bringing the total balance of holdings at 669.6 billion yen as of December, BOJ data showed.

The surge of its portfolio has led to the BOJ owning more than 9% for some REITs. An estimate by Mizuho Securities showed the BOJ owned more than 9% for seven out of the 23 REITs it held as of January, including Japan Excellent and Fukuoka REIT.

The BOJ did not immediately respond to a request for comment. The central bank normally does not comment on policy, besides public speeches and briefings by its board members.

BOJ Governor Haruhiko Kuroda has said the review won’t lead to a tightening of monetary policy.

But many BOJ officials are wary of relaxing rules for an unorthodox programme like J-REIT purchases, which critics say distorts prices and exposes the bank’s balance sheet to risk.

“Unless markets are under huge stress, it’s hard to relax the rules,” said an official familiar with the BOJ’s thinking.

($1 = 107.0200 yen)

(Reporting by Kentaro Sugiyama and Leika Kihara; Editing by Muralikumar Anantharaman)

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German watchdog puts Greensill Bank on hold due to risk concerns



German watchdog puts Greensill Bank on hold due to risk concerns 2

By Tom Sims and Tom Bergin

FRANKFURT/LONDON (Reuters) – Germany’s financial watchdog warned of “an imminent risk” that Greensill Bank would become over-indebted on Wednesday as it imposed a moratorium on the lender making disposals or payments.

BaFin’s move is another blow to the bank’s owner, Greensill Capital, which said on Tuesday it is in talks to sell large parts of its business after the loss of backing from two Swiss asset managers which underpinned key parts of its supply chain financing model.

Greensill, which was founded in 2011 by former Citigroup banker Lex Greensill, helps companies spread out the time they have to pay their bills. The loans, which typically have maturities of up to 90 days, are securitized and sold to investors, allowing Greensill to make new loans. Greensill’s primary source of funding came to an abrupt halt this week when Credit Suisse and asset manager GAM Holdings AG suspended redemptions from funds which held most of their around $10 billion in assets in Greensill notes, over concerns about being able to accurately value them.

Two sources told Reuters on Wednesday that SoftBank-backed Greensill Capital is preparing to file for insolvency, adding that the sale talks were with U.S. private equity firm Apollo.

Greensill and Apollo did not immediately respond to requests for comment on Greensill’s insolvency preparations, which were earlier reported by the Financial Times, or on the sale talks.

Japan’s SoftBank, which has invested $1.5 billion in recent years in Greensill, also declined to comment.

BaFin said an audit found that Greensill Bank could not provide evidence of receivables on its balance sheet purchased from mining tycoon Sanjeev Gupta’s GFG Alliance. GFG did not respond to a Reuters request for comment on BaFin’s findings.

“The moratorium had to be ordered to secure the assets in an orderly procedure,” BaFin said in a statement, adding that the Bremen-based bank would be closed for business with customers. It declined to elaborate.

Greensill Capital said in a statement that Greensill Bank always “seeks external legal and audit advice before booking any new asset.”


Greensill Bank had loans outstanding of 2.8 billion euros and deposits of 3.3 billion euros at the end of 2019, rating agency Scope said in an October report, which did not detail the bank’s exposure to GFG.

The bank is a member of the Compensation Scheme of German Banks which means deposits up to 100,000 euros ($120,740) are protected. The German regulator said withdrawals were not currently possible, but gave no further detail in a statement.

Prosecutors in Bremen said earlier they had received a criminal complaint from BaFin regarding Greensill Bank, but did not provide further details on it.

In Britain, meanwhile the financial regulator took action against GFG’s own trade finance arm Wyelands Bank. The Bank of England’s Prudential Regulation Authority said it had ordered Wyelands to repay all its depositors. It said in a statement that it had been engaging closely with Wyelands, but did not say why it had taken the action.

GFG said Wyelands, which had over 700 million pounds ($979 million) of deposits according to its latest annual report, would repay deposits and planned to “focus solely on business advisory and connected finance”.

A GFG spokesman declined to comment on the BoE statement.

Credit Suisse said on Wednesday it is looking to return cash from its suspended funds dedicated to supply chain finance, which is a method by which companies can get cash from banks and funds such as Greensill Capital to pay their suppliers without having to dip into their working capital.

“Given the significant amount of cash (and cash equivalents) in the funds, we are exploring mechanisms for distributing excess cash to investors,” Credit Suisse said in a note to investors on its website.

Credit Suisse said that more than 1,000 institutional or professional investors were invested across its funds.

($1 = 0.8282 euros)

($1 = 0.7153 pounds)

(Reporting by Tom Sims and Patricia Uhlig in FRANKFURT and Tom Bergin in LONDON; Additional reporting by Brenna Hughes Neghaiwi and Oliver Hirt in ZURICH; Editing by Alexander Smith)

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Britain to review surcharge on bank profits



Britain to review surcharge on bank profits 3

LONDON (Reuters) – Britain’s finance minister Rishi Sunak has said the government will review the surcharge levied on bank profits, in a bid to keep the UK competitive with rival financial centres in the United States and the European Union.

Sunak said in his Budget statement on Wednesday he was launching the review so that the combined tax burden on banks did not rise significantly after planned increases to corporation tax.

Leaving the surcharge unchanged would make UK taxation of banks “uncompetitive and damage one of the UK’s key exports”, the government said in its Budget document.

Changes will be laid out in the autumn and legislated for in the forthcoming Finance Bill 2021-22, the document said.

The surcharge on bank profits raised 1.5 billion pounds for the government in 2020, the document showed.

It is separate to the more lucrative bank levy on bank balance sheets, which raised 2.5 billion pounds.

(Reporting by Iain Withers, Editing by Huw Jones)

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