Ardian Fullani: How the financial crisis has impacted central bank
cooperation and EU economic, financial and regulatory developments
Speech by Mr Ardian Fullani, Governor of the Bank of Albania, at the high-level conference
"On international central bank cooperation before, during and after the crisis", hosted by the
European Central Bank, Frankfurt am Main, 9 December 2013.
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Dear Participants,
It is an honor for me to participate in this important conference and I want to thank the
organizers for inviting me. In my speech I will focus on how the recent financial crisis has
changed the central bank work with respect to the adoption of macro-prudential policy and its
relationship with monetary policy. Then I will share some thoughts on the experience of SEE
countries during the crisis, and highlight some of the challenges they face given the recent
economic, financial and regulatory developments in the EU.
The crisis we are going through, being so profound and lasting, will leave its mark on
economics in general, and central banking in particular. Up until the Great Recession,
monetary policy was living in a world that we may call "the inflation targeting era". In many
ways inflation targeting made the central bank's job relatively simple, as long as it followed
the policy correctly. The Central Bank, seen by the public as an independent institution, had
to credibly commit to an explicit inflation target, in order to anchor mid-term inflation
expectations. Self-fulfilling expectations from economic agents and price setters would, in
turn, help deliver the objectives of monetary policy. Economists believed that by stabilizing
consumer prices, financial assets would also behave in a stable and predictable way. The
crisis painfully reminds us that behavior in financial markets is not always rational and lack of
confidence in the markets can spiral out of control, sending shockwaves throughout the
economy. Escalating asset prices and their sudden burst affected significantly the behavior
and balance sheets of the economic agents and challenged the stability of the financial
system. In this respect, the concept of financial stability was seen as a byproduct of
monetary stability.
Micro-prudential supervision was focusing on the soundness of individual financial
institutions, with the belief that this was sufficient to ensure aggregate stability of the financial
system. Again, the recent financial crisis made it clear that micro-prudential supervision was
insufficient to detect and address buildup of risks in the entire financial system due to
externalities, herd behaviors, common exposures and pro-cyclicality in financial system
activity. Moreover, financial institutions of systemic importance proved to be "too big to fail"
and measures were needed to deal with existing systemic institutions on a global and local
level. Recovery and resolution powers of financial institutions are being strengthened.
Limiting systemic risk, both in its time and structural dimension, is the objective of
macroprudential policy. In the last 3 years, there has been significant progress in the identification
of several instruments designed:
• to address the rapid expansion and concentration in lending activity;
to ensure that banks have sufficient liquidity to cope with different shocks;
•
• and to discourage risky behavior by financial institutions by increasing demand for
capital for such activities.
These measures may have countercyclical nature and could apply to financial institutions
based on their systemic importance.
These standards require building an institutional framework with clear identification of the
authority /authorities that will have macro-prudential powers, in accordance with the structure
and level of market development. Central bank appears to be better positioned than other
authorities to perform the macro-prudential role. In addition to its exclusive responsibility on
formulating and implementing monetary policy, central bank has other advantages related
with:
• its involvement in developing the payments systems infrastructure;
• its access to wide market and financial system data;
• and, many times, its role as a regulator and supervisor of banks.
Nowadays it is widely accepted that there has been huge progress worldwide in ensuring
legal and operational independence of the central bank and this is another important reason
why it can be entrusted with macro-prudential policy.
In order to correctly define the macro-prudential function of the central bank, it is important to
establish the right relationship with monetary policy. This can be done with the understanding
that both policies, if designed and implemented properly, complement each other. Monetary
policy can still pursue its course following low inflationary pressures, while the
macroprudential measures can be used to address early risks developing under a low interest rate
environment. On the other hand, macro-prudential measures can also be used to mitigate
risks from incoming capital flows, in an environment of relatively high real interest rates.
Instances of conflict among the two policies should not be neglected though. These
instances can be more pronounced if the objectives of the two policies are wrongly defined in
a certain financial situation, or respective tools are used out of their scope. For this reason, I
believe that it might be helpful to uphold the monetary policy as the primary objective of the
central bank. Stabilizing inflation should be something that central bankers may be proud of,
something that we should cherish and continue to strive for. But we must recognize that
financial stability issues and related macro-prudential measures have to gain significantly
more grounds in central bank discussions and decisions. Clearly, the course of the monetary
policy will continue to be extensively discussed in the future, based on our improved
understanding of the role of asset prices and financial frictions. Incorporating financial
stability objectives with the inflation targeting regime we have considered in Albania as an
opportunity to understand and address economic developments and potential
macrofinancial risks, in order to preserve long-run economic stability.
While the mandate on macro-prudential policy and its tools must be clear, one has to
recognize that it can have wider effects in financial system and the real economy. For this
reason, discussions on macro-prudential policy and measures must involve other authorities,
including the fiscal one. Many countries have now established an inter-institutional entity with
soft or hard powers in designing and implementing macro-prudential policy to mitigate
systemic risk. The role of the central bank in these inter-institutional entities will reflect their
legislation and tradition, and independence objective. Although central banks may not always
chair such entities, central banks play a critical role in underpinning their functioning given
the information and expertise they provide.
How have such policies developed in the South Eastern Europe (SEE) region?
In spite of solid growth in the run up to it, the global crisis found SEE in a vulnerable position.
To a large extent, its growth model was based on encouraging domestic absorption which in
turn was partly financed through external borrowing. Financial inflows were channeled in
SEE economies largely through EU bank subsidiaries. In SEE, they encouraged investment
in real estate and services sectors and were reflected in large current account deficits.
External competitiveness and structural reforms slipped gradually through the policymaker's
agenda, while fiscal positions were allowed to deteriorate and financial safety nets were
weak.
As a result, when the crisis hit SEE faced both a structural and a cyclical problem. The
overall economic structure was not competitive while growth declined as external demand
collapsed and domestic demand suffered from higher uncertainties, higher risk premium and
lack of funding. On the financial side, our economies suffered as foreign banks deleveraged
and reduced their exposure to SEE. On top of this, several countries faced high
vulnerabilities in the financial system, as the NPL's grew rapidly on a combination of weak
growth and FX currency loans to un-hedged borrowers.
This picture is of course a generalization. Different countries have had different experiences,
depending from their initial conditions and policy responses. However, the crisis exposed
several weaknesses of this economic model. At the same time, to the extent that there are
differences among countries, we can draw more conclusions from our experience:
• Countries with favorable initial conditions suffered the least. Albania has been one
such case. We have not entirely avoided the build-up in imbalances, but we have
been careful enough to avoid currency mismatches in bank lending, to foster a
prudent business model for the banking system, to avoid short-term currency inflows
and to focus on overall stability as a precondition for long term growth.
• Countries with stability and long-term oriented policies have performed better. The
policy dilemma in SEE has largely been whether to support economic growth
through countercyclical policies or to prioritize economic and financial stability
through tough corrective action. Providing macroeconomic stimulus if your economy
is import-oriented may prove to be a futile exercise. As a result, in Albania we have
increased our efforts to restructure the economy. The BoA has also sought to
increase transparency in the banking system and to strengthen its balance sheets,
both through capital increases and through tackling bad loans. The latter has been
done through promoting credit restructuring or credit write-offs. In this regards the
focus of bank of Albania will include a micro-approach in analyzing the bad debtors
of systemic importance.
• International cooperation is a prerequisite for mitigating contagion effects and for
successful crisis management. Particularly, the Vienna Initiative has been
instrumental in limiting the deleveraging process of the private banking system in
our economies.
Safety nets have to be improved, in order to make them more efficient and
•
sustainable.
Several issues remain to be solved. SEE economies have rightly chosen integration in EU as
their main goal. It helps to anchor their political systems, their structural reforms, their legal
and regulatory environment and their macroeconomic and financial policies. However, the
economic growth model has to change. The main focus of national authorities in SEE should
be to facilitate the allocation of capital to more productive sectors, by providing the right
incentives structural reforms, legal environment, tax policies, and economic stability.
In the financial system of these countries, dominated by banks, the deleveraging process is
undergoing under the pressure of the deteriorating loan quality. Credit is made scarce as
banks have become risk averse and hesitate to lend to potential borrowers by tightening
lending terms. Hence, real sector agents, particularly firms operating in ailing sectors of the
economy, are facing surmounting short-term financing difficulties and have lost sight of their
future objectives. The process of restructuring in these firms has to find ways for their
business to change and become efficient, in order to survive and restart growth. Finance and
knowhow is particularly important during such restructuring phase.
What role has the financial system in this process? We have to be clear on two issues: (1)
we have constructed a financial system and pursued a financial integration strategy based on
banks. In fact, they comprise more than 90% of the financial system throughout the region.
We think this model is successful and with some minor revisions should serve our economies
in the future. For one, foreign banks bring expertise and mostly stability to the financial
system. But, recent experience has softened this argument. (2) Banks should be the main
vehicle of financial inflow. As converging economies SEE is expected to run current account
deficits. As such, it is a capital hungry region which international banks should intermediate.
A new business model relying purely on domestically generated deposits is a wrong answer
to the previous extreme of huge capital inflows. A more happy medium should be sought,
one based on careful and sustainable inflow of funds.
How is the Single Supervisory Mechanism going to affect the work of the central
banks in the region?
I believe the SSM mechanism is going to have a positive impact on central bank (and
regulatory authorities) in the region discharging their responsibilities with regard to
supervision and macro-prudential policies. Regulators in the region will now talk to a single
"home" supervisor, and this is expected to bring more attention to their supervisory concerns.
This process could be strengthened further if the central banks in the region improve their
own cooperation and are able to identify common position in their communication with the
European Central Bank. This could address better the concern that the single supervisor
could be more distant to worries of regulators coming from small countries in the region.
Being able to cooperate with a single "home" supervisor, will be instrumental in achieving
faster progress in the process of regulatory convergence, and establish a more level playing
field for financial institutions in the region. This is something that is being closely guided by
the Vienna II Initiative. In addition to preparing implementation of various regulatory
standards related with countercyclical macro-prudential tools, with particular short term
importance is the issue linked with recognition and the treatment of the NPL.
In the recent past, some of the countries in the region have been affected by the
deleveraging process started in the EU financial system. This was mostly felt during 2012,
following the higher capital requirements associated with EBA stress test of November 2011
and relevant steps taken by national "home" authorities to comply with capital requirements.
Next in line is the Asset Quality Review by the ECB. Our hope and belief is that this time,
concerns of the SEE countries regarding potential further deleveraging, will be considered
more carefully and more specifically, to avoid further potential deleveraging. Let me reiterate
that the economies in our region currently rely heavily in bank financing and there is a
growing need to make credit flow again in the economy.
To conclude, allow me to point out the importance of establishing a sound framework for
macro-prudential policy, both in terms of tools and institutional approach, in order to deal
effectively and timely with prevention of systemic risk. They should be accompanied
however, by measures related with the strengthening of crisis management framework. If
designed properly, macro-prudential policy should avoid any conflict with monetary policy,
and instead should complement it appropriately. Countries in the SEE should benefit from
synergies related with the adoption of the Single Supervisory Mechanism. These benefits
could be larger if we manage to strengthen our regional cooperation. We are still concerned
with potential further deleveraging following the forthcoming Asset Quality Review process
and we hope that ECB and other authorities in the Eurozone and EU, could design it to limit
these impact in maximum.
Thank you very much for your attention!