Pablo Hernández de Cos: Navigating through a storm - policy
challenges in the current macro-economic environment
Introductory address (via video) by Mr Pablo Hernández de Cos, Governor of the Bank
of Spain, at the pannel "Navigating through a storm - policy challenges in the current
macro-economic environment", during the Sixth European Systemic Risk Board annual
conference "Addressing financial stability challenges", Frankfurt am Main, 8 December
2022.
* * *
Good afternoon everybody and welcome to this first discussion panel of the Sixth
Annual Conference of the European Systemic Risk Board.
In this roundtable, we will be discussing and sharing views on identified challenges
affecting the conduct of policies in the current turbulent times, which are having
important repercussions for the economic and financial environment.
As noted by President Lagarde, during her welcome address, in the course of this year
we have witnessed an increase in financial stability risks.
The appalling invasion of Ukraine by Russia, initiated as we were recovering the activity
levels previous to the pandemic, has contributed to either fuel new or exacerbate
existing systemic vulnerabilities in Europe and beyond.
Spikes in energy and food prices, continued disruption of global supply chains and
demand pressures have resulted in higher and more persistent inflation across the
board.
This has triggered a response of monetary policy, which is now normalising around the
world, contributing to tighter global financial conditions and increased volatility
and liquidity tensions.
And it is the combination of the uncertainty derived from the war (and more in general
from geopolitical tensions) with the increase of inflation and the rising interest rates that
has generated, ultimately, a general deterioration of the economic outlook with, for
example, one-year ahead recession probabilities having increased markedly, in both
the euro area and other major advanced economies.
This challenging financial stability outlook is well laid out in the
Warning on
vulnerabilities in the EU financial system that the European Systemic Risk Board
issued last September.
Indeed, the ESRB has alerted of the heightened uncertainty and the increased
probability of tail-risk scenarios materialising.
In particular, the ESRB has warned of three severe systemic risks :
(i) first, the
deterioration in the macroeconomic outlook combined with the
tightening of financing conditions, leading to negative consequences in terms of
balance sheet stress for non-financial corporations and households, especially in
sectors and Member States that are most affected by rapidly increasing energy
prices.
(ii) second, a possible sharp fall in asset prices , leading to large mark-to-market
losses, amplified market volatility and liquidity strains. In addition, the increase in
the level and volatility of energy and commodity prices has generated large margin
calls for participants in these markets and this has created liquidity strains for some
participants.
(iii) and third, the potential deterioration of asset quality and the profitability
outlook of credit institutions. While the European banking sector as a whole is
well capitalised, a pronounced deterioration in the macroeconomic outlook would
imply a renewed increase in credit risk at a time when some credit institutions are
still in the process of working out COVID-19 pandemic-related asset quality
problems. Without forgetting that the resilience of credit institutions is also affected
by structural factors, including overcapacity, competition from new providers of
financial services as well as exposure to cyber and climate risks.
Besides, the ESRB has identified a number of other risks that are deemed elevated ,
in relation to imbalances in the residential and commercial real estate sectors -which
are more acute in some Member States than in others-, the likelihood of large-scale
cyber incidents, and high public indebtedness.
Summing up, there is no shortage of challenges and, in this context, preserving or
enhancing the resilience of the Union's financial sector remains essential to
ensure its capacity to support the real economy if and when financial stability risks
materialize,
- Credit institutions can act as a first line of defence, by ensuring that their
properly account for expected and
provisioning practices and capital planning
unexpected losses that may be caused by the deterioration in the risk environment.
- Micro- and macroprudential capital buffers that are consistent with the
prevailing level of risk can also help to ensure credit institutions' resilience. Some
national authorities have already tightened macroprudential policies, while others
are currently exploring whether these policies could be implemented to address
vulnerabilities. Preserving or further building up macroprudential buffers would
support credit institutions' resilience and enable the authorities to release these
buffers, if and when risks materialise and negatively impact credit institutions'
balance sheets. But, as ever, these decisions should be made considering each
Member State's specific macrofinancial outlook and banking sector conditions, in
order to limit the risk of procyclicality.
- Financial stability risks beyond the banking sector should also be addressed.
This requires tackling vulnerabilities and increasing the resilience of non-bank
financial institutions and market-based finance. In this regard, the ESRB has
repeatedly noted that a lack of tools is hampering authorities' ability to address
financial stability risks beyond the banking sector. It has called for authorities to be
provided with such tools, for example, in the context of the review of the prudential
rules governing investment funds and insurers. The current heightened risk
environment makes this more urgent.
Against this background, let me now turn to the four distinguished panelists that are
together with me today: Claudio Borio, Alfred Kammer, Lucrezia Reichlin and Ricardo
Reis, who are very well known to you in the audience and, therefore, need little
presentation.
Let me, anyway, briefly introduce them to you, by alphabetical order:
Claudio Borio is the Head of the Monetary and Economic Department of the Bank
for International Settlements. He has held various positions of responsibility at the
BIS over the last 35 years and during this period he has authored numerous
publications in the fields of monetary policy, banking, finance and issues related to
financial stability.
Alfred Kammer is the Director of the European Department at the International
Monetary Fund. In that capacity, he leads and oversees the IMF's work with Europe on
financial sector surveillance, monetary and macroprudential policies and financial
regulation, among other key areas.
Lucrezia Reichlin is Professor of Economics at the London Business School with
a background in central banking. She was previously Director General of Research at
the European Central Bank.
Last but not least, Ricardo Reis is the A.W. Phillips Professor of Economics at the
London School of Economics. Widely regarded as one of the top research
macroeconomists of his generation, Ricardo has published extensively on monetary
and fiscal policy, inflation and business cycles.
Thank you Claudio, Alfred, Lucrezia and Ricardo for kindly accepting the invitation to be
with us today. As discussed with you, I would first give the floor to Alfred.