Stefan Ingves: Time to rethink - inside the head of a central bank
governor
Speech by Mr Stefan Ingves, Governor of the Sveriges Riksbank and Chairman of the Basel
Committee on Banking Supervision, to the Swedish Economic Association, Stockholm
School of Economics, Stockholm, 6 April 2016.
* * *
I would like to thank several of my colleagues who have contributed to this speech: Mikael Apel, Maria Bergsten,
Charlotta Edler, Pernilla Meyersson, Johan Molin, Christina Nordh-Berntsson, Cecilia Roos-Isaksson, Marianne
Sterner, Gabriel Söderberg, Anders Vredin and Anna-Lena Wretman.
New challenges - new choices
The Riksbank is - like other central banks - in a position where strategies and regulatory
frameworks are being scrutinised and questioned more intensively than at any time over the
past twenty years. The experiences of the latest financial crisis suggest politicians and
central bank economists must be prepared to try new approaches. Today, I intend to discuss
the challenges and questions facing central banks the world over.
How should monetary policy be conducted? What consideration should be given to real and
financial variables, in addition to the inflation target? What role should central banks have as
regards financial stability and supervision? How is this role changing as a result of new
innovations in payments and in the financial system more generally? What factors affect how
independent central banks should be and how political oversight and influence should be
exercised?
Many central banks the world over are facing a similar set of problems. This is partly due to
globalisation, not least financial globalisation. It affects the scope of countries and thereby of
central banks to conduct their own economic policy based on national prerequisites. Sweden
is a small, open economy with a large financial sector. The room for manoeuvre in economic
policy regarding both monetary policy and financial stability is, in my opinion, much less than
it was for, say, 15-20 years ago. According to the textbooks, with a floating exchange rate,
we should be able to conduct an independent monetary policy. And we can, but to what
extent? Today's low inflation is, for example, very much a global phenomenon.
Stability in the financial system is also affected by financial globalisation. As a consequence
of the ever-stronger links between different countries' financial systems, regulatory
frameworks are also increasingly often formulated outside national borders. The
strengthening of global financial regulatory frameworks is, of course, also a result of the
financial crisis which broke out in 2008 - and the after-effects of which the global economy is
still struggling with.
I would, however, like to stress that in Sweden we coped relatively well with the financial
crisis and its aftermath. We had robust frameworks and the power to act, as regards both
fiscal policy and monetary policy. We also had enough flexibility to be able to cope with the
Swedish banking system's need for liquidity and assist other countries in our vicinity in order
to help stabilise the financial system. Economic development in Sweden has been favourable
in many ways. The economy grew by over 4 per cent last year. The situation on the labour
market continues to improve and unemployment is falling. Inflation has also begun to rise,
albeit from low levels. The very expansionary monetary policy in recent years has contributed
to this healthy development. However, risks have built up in the Swedish economy -financial
imbalances - such as the growth of household debt.
As regards monetary policy, my conclusions are that our policy of flexible inflation targeting
has largely worked well. New experiences and research suggest that there are a few things
that we should perhaps modify in order for it all to work even better. I will go into more detail
about the things I am referring to.
As regards financial stability, a much more major rethink is required. In Sweden, there are
major flaws with vague mandates, unclear processes and inefficiency in the work to create a
more robust financial system, all of which threaten financial stability in the long run. Issues
concerning both monetary policy and financial stability have been and remain the
cornerstones of central bank operations.
To explain this, and at the same time describe the extent of the challenges facing central
banks today, I would like to begin my presentation with what historically has been the basic
function of central banks, namely to provide a country with a standardised product for the
exchange of goods and services - money. Indeed, financial globalisation and digitalisation
are also challenging the perception that central banks have a monopoly on the issuing of
means of payment.
The Riksbank's responsibility for cash management has changed
By law, the Riksbank shall supply the country with banknotes and coins and has the
exclusive right to issue them. The law also states that these banknotes and coins are legal
tender. Giving central banks a monopoly on the issuing of banknotes and coins, along with a
certain degree of autonomy, has been seen as an effective and credible way of managing
the supply of means of payment.
Payment trends have a long history. From bartering and the first silver coins in Sweden in
995, to the first standardised and collective means of payment in the form of transport bills,
which were introduced during the 17th century. Besides cash being much more modern
today than when the Riksbank was founded almost 350 years ago, we also have access to
several different electronic payment options.
The Riksbank' responsibility for means of payment has been adapted over time as needs
have changed. At one point, the Riksbank had over 20 offices around the country, basically
one in every county, where banks often deposited and withdrew cash. For a period, the
Riksbank also accepted daily takings directly from companies. The Riksbank counted,
performed quality checks, invalidated and stored cash. Over time, the Riksbank has
rationalised and adapted its cash provision. Today, it is banks and other private entities who
are responsible for the distribution of cash. The Riksbank's banknote and coin operations are
centralised to an ultra-modern office north of Stockholm.
And the Riksbank's role continues to change. An inquiry has proposed that the Riksbank
should be given an overarching responsibility for monitoring and analysing cash
management.1
The Riksbank is prepared to take on this responsibility as it falls quite
naturally within our remit as a central bank. The inquiry has also proposed that cash
processing companies, such as Loomis and Nokas, should come under the supervision of
the Riksbank. It is important for someone to exercise supervision over these operations and
companies. I am doubtful whether the Riksbank is the authority best suited for this task,
although that is of course a matter for the Riksdag to decide.
Should the Riksbank issue electronic money?
But developments have not just been a matter of reorganising the more operational side of
cash management. Technical developments, globalisation and innovations on the financial
markets also challenge the perception that it is necessary for the central bank to have a
monopoly on issuing cash to ensure a safe and efficient payment system. Banknotes and
coins have long since faced competition from other means of payment, especially different
types of accounts with their related payment services offered by banks and other financial
institutions. Today, payments are made electronically to a large extent; both households and
companies, for example, pay invoices and transfer money online or by mobile phone. And in
recent years, virtual currencies such as Bitcoin have been introduced. What responsibility
central banks should have for the security and efficiency of electronic means of payment
needs to be more closely examined.
The overarching question is whether it is important for there to be a "state means of
payment" in order to maintain confidence in the payment system. If the answer is yes, we
need to ask ourselves whether the issuing of private means of payment should be restricted
or regulated more than it is today. Or should there perhaps be access to electronic Riksbank
cash in the future? This is an example of very interesting questions that require new ways of
thinking as well as considerable research.2
Risk of over-confidence in market mechanisms
Payment innovations are intrinsically positive and good for society. They give us faster and
more easily accessible payment methods that simplify our daily lives and contribute to
continued growth. But there are also risks associated with them. It is in society's interests
that everyone can make payments in a simple and standardised way A report into the
subject, on whether the right to payment accounts should be incorporated into Swedish law,
was recently circulated for consultation.3 The directive says that all those who live within the
EU's borders shall have access to a bank account with basic payment features. It talks in
particular about the possibility of withdrawing and depositing cash and of course of making
payments, both in person and online. At the Riksbank, we consider there to be a risk of
overconfidence in the market taking its responsibility for cash supply, both now and in the future.
In our consultation response, we therefore propose that the market's responsibility for giving
customers access to a payment account and related cash services be regulated more
clearly; or that the law include an option for the state to intervene if the market fails,
regarding both cash and electronic payments. Despite everything, there is still a long time to
go before Sweden becomes a cashless society. There is still SEK 73 billion in circulation in
the form of 317 million banknotes and 1.9 billion coins - a significant sum of money.
The Swedish payment system RIX will change
But the Riksbank's role as regards payments is not just limited to ensuring the availability of
cash. The Riksbank's system for payments between banks and a number of other financial
institutions - the RIX system - is the hub of the Swedish payment system. All payment
transactions between banks, clearing organisations and the National Debt Office pass
through RIX.4 This makes it an important part of the Swedish financial infrastructure with a
daily turnover of about SEK 450 billion divided among over 15,000 payments. The
development of payment services makes adjustments of the RIX system necessary. An
example is the development of payments in real time using, for example, the Swish mobile
phone app. Here at Riksbanken, we have made it possible for the payment service to work
even when the RIX system is closed by allowing a small amount of central bank money, in
the form of a loan, to be outstanding during the night.
Which financial institutions are participants in RIX is affected by developments on the
financial markets. In a Nordic comparison, Sweden has so far had relatively few participants
as members in the system and a situation where four participants are responsible for 80 per
cent of the turnover. This is now changing and the Riksbank will have to consider smaller
and perhaps entirely new participants who also wish to manage their payments to and from
the banks, and between themselves, via RIX. For example, Forex Bank and JAK
Medlemsbank will soon participate in RIX. To maintain healthy competition and efficiency in
the financial system, it is important that the Riksbank treats everyone equally, although it is
also important to have a safe and secure payment system.
As a result of the Riksbank's responsibility for RIX, a government enquiry from 2011
proposed that the Riksbank should be given the responsibility for coordinating crisis
5
preparedness in the payment system via a new law. This proposal has yet to be realised.
Parts of the inquiry's proposal were nevertheless implemented voluntarily but we consider
that this coordination responsibility should be made statutory and provide the possibility to
place binding requirements on the payment system's participants. No authority currently has
such a responsibility and neither is there an authority responsible for producing an overall
risk and vulnerability analysis.
Ability to create unlimited liquidity in SEK
Among the Riksbank's many tasks is the important role of providing liquidity in the event of a
crisis. There are certainly good reasons to believe that the function of banks in society -
facilitate payments, mediate credit, enable risk diversification - is more efficient as a result of
competition among private players rather than being run by the state. But banking operations
also have an inherent vulnerability. The banks' funding is based to a considerable degree on
short-term loans, for example deposits from the general public and short-term borrowing on
the capital market. Their assets, on the other hand, often comprises lending of a more
longterm nature. This mismatch in maturity and liquidity between debts and assets is typical for
traditional banking operations and does not constitute a major problem as long as confidence
is maintained in the banks' debt-servicing ability. But if doubts arise, depositors may quickly
try to withdraw their money - money that the bank cannot obtain in the short run. This
causes a liquidity problem. This type of inherent risk is the reason why there are special rules
for banks, supervision and, for example, a deposit guarantee protecting depositors against
losses.
Furthermore, a central bank can mitigate the effects of such a crisis by ensuring that there is
money available when no one else wants to lend. This function as lender of last resort is
based on the central bank's unique ability to create unlimited amounts of liquid funds in its
own currency.6 According to the classic doctrine, the central bank can give generous
emergency liquidity assistance (ELA) at a high rate of interest and against good collateral.7
The ability of central banks to act as lender of last resort has had major significance in many
financial crises, and was particularly important during the financial crisis of 2007-2009. This
crisis led to a number of financial institutions encountering difficulties which ultimately caused
the global financial markets to stop functioning. The shortage of liquid funds and credit
threatened the entire global economy. Central banks around the world were forced to take
extensive measures to handle the situation. These measures included loans in various
currencies and the purchase of large volumes of government securities, as well as other
assets. Several of them were also used during the subsequent sovereign debt crisis in the
euro area. Sweden was also affected and the Riksbank decided to provide liquidity to
Swedish institutions. The Riksbank's balance sheet exploded, from SEK 212 billion at the
end of 2007 to, at its peak, SEK 763 billion in the summer of 2009. In my opinion, the
measures have overall been necessary due to the extraordinary circumstances. They have,
however, created major challenges which central banks must now come to grips with.
Central bank support can increase risk-taking
Society's safety net, in the form of measures such as giving banks ELA, means that we can
counteract the risk of problems in one bank developing into a widespread systemic crisis.
The Lender of last resort function could therefore be seen as a form of insurance. But just
like all other types of insurance, this one can also have a negative impact on the
beneficiaries' risk behaviour if there isn't a sufficient level of excess in the system. There has
been an obvious risk of the expansion of the safety net that occurred during the crisis leading
to greater risk-taking and thereby increasing the probability of the safety net needing to be
used in the future.
To counteract this, it has been necessary to increase both the excess and resilience in the
financial system. As a result, a new crisis management framework has been introduced, the
aim of which is to force the banks' shareowners and creditors - excluding, I would clearly like
to point out, those depositors protected by the deposit guarantee - to take a greater
responsibility for losses in the event of a default. Furthermore, the requirements regarding
the banks' capital and liquidity buffers have been tightened. In my opinion, these
requirements can be even clearer and adapted to the conditions prevailing in the specific
banking system. Bearing in mind the dependence of Swedish banks on funding on
international capital markets and extensive foreign operations, the requirements regarding
banks' liquidity buffers - sometimes referred to as Liquidity Coverage Ratios - or LCRs -
should be expressed in relevant currencies, including Swedish kronor.8 It is also important to
have high capital requirements.
Lender of last resort for an increasing number of players
Traditionally, systemic risks have been primarily associated with large banks. But
developments in the financial sector have made it more difficult to assess where the systemic
risks are. This is due to structural changes as a result of both new regulations and financial
innovations. In both the Swedish 1990s crisis and the global financial crisis, a grey credit
market and a shadow banking sector emerged that evaded the supervision of the authorities
and to an extent took over the activities of traditional banks. The risks that were built up in
the unregulated sector formed the basis of the system-wide crises that subsequently broke
out.9 It is therefore important that supervision and regulation keep up with and are adapted to
developments and structural changes that occur in the financial sector. Central banks may
also from time to time review their guidelines and arrangements for liquidity assistance so
that they are sufficiently flexible in order to meet new requirements. There may, for example,
be reason to consider the forms in which types of companies other than banks might also be
eligible for liquidity support.
One such type of player is so-called central counterparties. A central counterparty (CCP)
acts as a counterparty to the buyer and seller in a security transaction, thereby assuming all
counterparty risk. In order to reduce systemic risks globally, authorities around the world
have encouraged the use of central counterparties in transactions with standardised OTC
derivatives - such as interest rate swaps. The idea is that this will increase resilience in the
financial system in the event of a bank failing. Now that central counterparties are
increasingly used, it also means that some of the risk individual banks previously had in
relation to each other is instead concentrated to central counterparties, which makes these
players extremely systemically important. We are therefore now faced with the question of
whether they should also be given the opportunity to borrow money from the central bank to
a greater extent than currently is the case.
ELA from central banks may therefore come into question for a more complex set of players
in the future. Where we draw the line regarding the type of institution that can obtain ELA and
what conditions should hence apply are obviously questions that central banks now face. If,
for example, central banks are in practice willing to give loans to institutions that are not
covered by the previously mentioned regulations, do we not then encourage the emergence
of new types of shadow banks and new risks?
Increased need for foreign currency in the event of a crisis
Widespread globalisation also means that many banks have substantial exposures in foreign
currencies, currencies which the national central bank cannot create itself.10 This is
particularly relevant for Sweden, which has a very internationally active banking sector.
When liquidity on the dollar markets slowed towards the end of 2007, swap agreements were
established between the Federal Reserve and other central banks, including the Riksbank.11
As a result of this arrangement and by pledging its foreign currency reserve, the Riksbank
could lend a total of approximately SEK 200 billion in US dollars. Conversely, swap
agreements were also established between the Riksbank and two of the Baltic central
banks.12
These experiences indicate that, in the future, even tougher requirements will be placed on
international cooperation between central banks. How should we organise this in the best
way? Can we expect other countries' central banks to always be able to assist with currency
in a crisis situation or must special agreements be drawn up? The development also raises
the issue of whether an international 'lender of last resort' is needed.13 These questions are
particularly important for Sweden, which has its own small currency. And they will become
even more relevant if the major Swedish bank Nordea carries out its plan to change from a
subsidiary to a branch structure. With the current subsidiary structure, the central banks in
the countries where Nordea has subsidiaries are responsible for providing ELA to them. After
the transformation into a branch structure, the Riksbank will take on the main responsibility
for providing ELA, should it be needed. This means that the Riksbank will have a greater
need of being able to obtain foreign currency in a crisis situation. Even if swap agreements
can be concluded proactively, which is not at all certain, there are no guarantees that they
can automatically be used in the event of a crisis or when we consider it necessary to do so.
It is the creditor who decides whether it wishes to lend in each specific situation.
The Riksbank has a responsibility for financial stability...
The measures and phenomena I have now spoken of have led to banks always turning to the
central bank in difficult times. Regardless of where the supervision is formally located, central
banks therefore exercise some de facto supervision of banks. Everyone knows that "the
central bank is where the money is" and that it is not willing to lend it to just anyone. For us at
the Riksbank to be able to fulfil our role as liquidity provider, we must have good access to
information on financial institutions and markets.
The fact that the banks have been subject to regular analysis by the Riksbank - both before
and after the deregulation of the financial markets in the 1980s - is a natural consequence of
their central role in the payment system and the special systemic risks with which their
operations are associated. The need for analysis changes over time, however, and
developments on the financial markets mean that the central banks' analyses must now
cover more than just banks.
It is a question of analysing central counterparties, insurance companies, shadow banks,
asset prices, risk premiums, different markets or different phenomena (market liquidity risk,
high-frequency trading, block chain technology, etc.) in the financial system. It is important
that central banks continuously "scan" the financial market and keep track of risks and
vulnerabilities in different places, all the time focusing on the system risk perspective. To
ensure this, it is vital that we can independently request all the information we consider
necessary to be able to perform our analyses. Not least the ability to provide ELA in an
effective manner - and simultaneously limit the risks to the state, by only giving assistance to
institutions that have liquidity problems but otherwise are healthy - requires good access to
information. It is the Riksbank's and ultimately the state's funds that are at stake here and it
can be a question of very large amounts.
...and it needs to be clarified
The Riksbank's task of promoting financial stability, not least via its responsibility for the RIX
payment system and our role as lender of last resort, requires analysis of risks and
vulnerabilities in the financial system. This also provides us with the right conditions to be
able to identify feasible measures in order to manage the risks. The Riksbank shares the
responsibility for preventing financial crises with the Government and other authorities, in
particular Finansinspektionen and the Swedish National Debt Office.
The Riksbank's responsibility in this area is expressed in the legislation as the task of
"promoting a safe and efficient payments system". More specific details are not given.
Goodfriend and King discussed this issue in their evaluation of the Riksbank that was
presented at the beginning of this year.14 In their opinion, the Riksbank's mandate should
include financial stability and this should be clarified in the Sveriges Riksbank Act. I agree
and welcome a discussion on how the responsibility should be formulated. An important
question is what formal role the Riksbank should have as regards preventive work aimed at
reducing risks and vulnerabilities in the financial system, including within the policy area of
macroprudential policy, which focuses on preventing and mitigating systemic risks.
Identifying systemic risks is nothing new in the world of central banking. What is new is the
emergence of macroprudential policy as a policy area. This means that, in addition to the
task of identifying systemic risks, clear mandates must also be defined for those who are to
be responsible for macroprudential policy. In addition, a tool-box of different measures that
can be taken to reduce systemic risks must also be developed. Neither are many of the tools
and measures currently being discussed entirely new, but were already in central bank
arsenals prior to the major wave of deregulations during the 1980s.
Flaws in the Swedish macroprudential policy framework
In Sweden, Finansinspektionen has been given the main responsibility for macroprudential
policy. In addition, there is a financial stability council - consisting of representatives of the
Government, Finansinspektionen, the National Debt Office and the Riksbank - which is a
forum for the discussion of financial stability issues. I believe that there are significant flaws
in several aspects of the Swedish framework for macroprudential policy.
Firstly, experiences so far of the Swedish framework indicate clear inadequacies in
decisionmaking power. An obvious example is the protracted discussions on the introduction of a
binding amortisation requirement. An important cause of the problem is that the
macroprudential policy objective is unclear and too narrow. For example, it should be made
clear that macroprudential policy instruments may be used not just to manage risks to
financial stability, but also to reduce risks created by the financial sector in the real economy.
It must also be clear that macroprudential policy includes the entire financial system and not
just the credit market. A clarified and broadened objective is also appropriate in order to bring
Sweden's framework in line with European standards.15 There is also a lack of clear and
expeditious procedures when new macroprudential policy tools are to be introduced.
Improvements are urgently needed here so that we can tackle risks in good time and such
procedures have also been recommended by the EU's macroprudential policy body, the
European Systemic Risk Board (ESRB).16
Secondly, the Swedish structure falls short also when it comes to clarity in the division of
responsibilities. Via its instruction, Finansinspektionen was given the responsibility to "take
measures to counteract financial imbalances with the aim of stabilising the credit market". No
definition of what Finansinspektionen's overall macroprudential policy task comprises has
been formulated, however. This problem is highlighted by the decision process for the
upcoming amortisation requirement. The Government has indeed tasked Finansinspektionen
to produce regulations that more closely define the amortisation requirement but at the same
time requires these regulations to be approved by the Government before
Finansinspektionen adopts them. This is not in line with the ESRB's recommendation that the
macroprudential authority should as a minimum be operationally independent from political
bodies.17 The importance of independence when adopting macroprudential policy measures
is also underscored by Goodfriend and King. This is, if anything, a return to the arrangement
that often prevailed prior to the deregulations of the 1980s.
A third problem with the Swedish macroprudential policy framework is that it has not been
established by law. Finansinspektionen's mandate in the macroprudential policy area is only
a government ordinance and the Stability Council is formally only a committee. This is
unfortunate as macroprudential policy is an important policy area and it is vital that a
longterm, sustainable structure is created for it, so that macroprudential analysis is not given
lower priority when other tasks require resources, and experiences from the crisis are
forgotten. The Stability Council has so far played an insignificant role in practice.
Sweden deviates from international and European standards
Sweden thus deviates - in several respects - from European standards as regards how its
macroprudential policy framework is designed. We have also organised the responsibility for
macroprudential policy differently to most of the other countries in Europe. In 13 EU Member
States, the responsibility has been given to the central bank, a similar number have given it
to a separate council and two countries (Sweden and Finland) have given it to the
supervisory authority.18 In addition, it is worth mentioning that the European Central Bank,
the ECB, has received a mandate that basically means that it shares the macroprudential
policy responsibility with the national macroprudential authorities in those countries that
participate in the Single Supervisory Mechanism. The ECB has the responsibility for a
socalled "top-up" of some of the macroprudential policy measures decided at national level -
i.e. to tighten the measures further if the bank feels it is necessary.
More generally speaking, it is a problem if Sweden chooses to deviate from international or
European standards, as it implies a risk of us losing international influence and of us having
problems to implement new regulations in an efficient and consistent way. And the problem
is particularly major given that we have a large banking sector by international comparison.
In light of this, there is also reason for us to reconsider whether we should apply to take part
in the EU's Single Supervisory Mechanism (SSM). Through this, the ECB has been given the
overall responsibility for supervision in the euro countries and in other EU Member States
that apply to and are permitted to take part in the SSM. For the past couple of years, the
ECB has been responsible for supervision in 19 of the 28 EU Member States. The ECB's
influence will strengthen over time as regards the design of both microprudential supervision
and macroprudential policy in Europe. Even if Sweden were to have only limited influence as
an SSM participant, since we are not in the euro area, we would nevertheless gain a better
insight into SSM discussions and could make our voice heard. As an outside country,
however, we would in practice have to accept, to a large extent, the implementation of
changes already agreed on by the ECB/SSM. The fact that Sweden has large, cross-border
banks is reason enough to believe that we will have to adapt to the SSM rather than the
other way around.
Need for "a rethink" - a reanalysis
It is clear therefore that our Swedish framework for macroprudential policy has major flaws in
the way its objective has been formulated, the processes for allocating tools, clarity in the
division of responsibility and in legal status. This is problematic as it has contributed to
delaying measures that can counteract the high and growing household indebtedness.
In their evaluation, Goodfriend and King point out that both the mandate and division of
responsibility for macroprudential policy are in need of review. I agree. Without going into
more detail about their concrete recommendations, I can see that, based on a
socioeconomic efficiency perspective, it would be appropriate to utilise the expertise,
experience and resources in the macroprudential policy area, possessed by the Riksbank in
its capacity as the central bank, in a better way than is currently the case.
There are many different ways of doing this, of which, from both an international and national
perspective, the most efficient in the long run would probably be to merge the Riksbank and
Finansinspe