John Hurley: Financial stability and recent market developments in
Ireland
Opening statement by Mr John Hurley, Governor of the Central Bank & Financial Services
Authority of Ireland, to the Joint Oireachtas Committee on Finance and the Public Service,
Dublin, 21 January 2009.
* * *
Good morning Chairman and members of the Joint Committee. Thank you for the invitation
to speak with you today. I am accompanied by Tony Grimes, the Director General of the
Central Bank and Tom O'Connell, Assistant Director General, Economics.
The Central Bank and Financial Services Authority of Ireland consists of the Central Bank
and the Financial Regulator, each with its own responsibilities. Among the Central Bank's
key responsibilities are the maintenance of price stability, the provision of liquidity and
contributing to financial stability. The Financial Regulator's key responsibilities are prudential
regulation focussed on the individual financial institutions and consumer protection.
In my own opening remarks, I would like to briefly recall the background to the current issues
in our financial system and in the economy more generally, up to and including the
nationalisation of Anglo Irish Bank, and to outline the on-going role of the Central Bank in
dealing with these issues. As you know, last week's Government decision regarding Anglo
Irish Bank was taken in consultation with the Central Bank and Financial Regulator. This
necessary decision reflects the commitment of the authorities here to maintaining the stability
of the financial system and demonstrates that whatever actions are necessary in that regard
will be taken. With reference to financial stability issues more generally, I will comment on the
actions taken by the authorities here to secure the stability of our domestic financial system,
particularly since the Lehman's bankruptcy last September.
The domestic economy
The Irish economy is currently going through a very difficult period and is facing into a
second consecutive year of contraction. The contraction in output is set to result in significant
job losses and a sharp rise in unemployment. Given the uncertainty as to the speed with
which the global financial market crisis can be overcome, the assessment of the domestic
economic outlook is especially difficult. What is certain is that we are in a significant
downturn and two courses of action are essential. It is imperative that we move to correct the
sizeable deficit in the public finances over a reasonable timeframe. It is also vital that we
improve our competitiveness, which has weakened steadily in recent years. This is
necessary to protect employment, to maintain and attract foreign investment and, over the
longer term, to improve the potential for the economy to grow. In our present circumstances,
pay developments need to take account of the changed outlook for inflation and the
extremely difficult situation facing the Government's finances. They also need to take
account of the necessity to restore competitiveness in a difficult international trading
environment so as to be in a position to avail of improved economic conditions worldwide
when these eventually emerge.
Notwithstanding current difficulties, Ireland's medium-term prospects are good. On the basis
of still favourable demographic trends and some improvement in productivity growth, Ireland
has the potential to grow strongly again in a few years. However, the achievement of this
potential is not inevitable and is contingent on sound economic management. In the short
term this will involve painful but necessary action to ensure long-run sustainability in the
public finances and to restore our competitive position.
The global financial crisis
When I last appeared before you in July, I pointed out that we were in a challenging
environment. At that time, we were experiencing a greater-than-expected slowdown in
domestic growth in conjunction with a generalised disruption in international money markets.
In mid-September this situation deteriorated dramatically with the failure of Lehman's bank in
the United States. This event served both to accentuate and accelerate the adverse effects
of the crisis across global financial markets.
Among developed countries, as confidence and trust waned, even the strongest banking
systems were affected. To protect financial systems, which are so vital to every country's
economy, policymakers internationally moved from interventions in individual institutions to
scaled-up assistance, including funding guarantees and recapitalisations, on a system-wide
basis.
I have made it clear over the last number of years that the Irish economy was facing an
increasing number of downside risks and that, if an international shock interacted with these
domestic vulnerabilities, it would give rise to serious consequences for our economy. In the
event, this is what occurred and a rebalancing in the domestic economy, which could have
been painful but manageable, has turned into a much more difficult challenge.
The excess supply of liquidity and large global imbalances, which emerged in the early years
of this decade, were major causes of the significant vulnerabilities that materialised within the
global financial system. These vulnerabilities included excessive credit growth, increasing
leverage in the financial sector, and a search for yield leading to an under-pricing of risk in
financial markets generally.
These developments had a marked influence on the Irish financial system. Although the Irish
banks avoided the toxic assets associated with the US subprime market, there were specific
domestic vulnerabilities, such as the banking system's strong credit growth, over-exposure to
property-related assets and growing dependence on international wholesale funding.
These domestic and international vulnerabilities were identified clearly in our Financial
Stability Reports in recent years. However, the severity, breadth and rapid onset of the
financial crisis that has developed and the consequent impact on the global economy is
unprecedented. This is reflected in the very large deterioration in financial stocks globally and
exemplified in our own market. The upshot of all these developments is that all banking
systems in advanced industrial countries have now required a number of rounds of support
from their respective authorities. We have seen actions in this regard by some of those
authorities again this week.
The Central Bank's response to the current crisis
The Central Bank has responded to the unfolding crisis in a number of ways.
Provision of liquidity
The Irish central bank, on behalf of the Eurosystem, and along with central banks globally,
has been providing significant volumes of liquidity to the banking sector, since major financial
stress began to become evident in autumn 2007. The Eurosystem entered this crisis with a
relatively broad collateral framework for supplying liquidity to banks, in comparison with other
major central banks. It has since made its liquidity more easily accessible for banks by
widening its list of eligible collateral, providing the funds on a full allotment basis and
extending the maturity of its operations. Other central banks have since moved closer to the
Eurosystem model.
Euro area monetary policy
In response to the turmoil, and the associated impact on the real economy, the Eurosystem
along with other major central banks, has eased monetary policy, in some instances, to
levels not previously seen. The Governing Council of the ECB has cut its policy interest rate
by 225 basis points cumulatively since last summer. This substantial fall in rates over the last
few months has been a response to reduced inflation risks at a time of deteriorating
economic and financial developments in the euro area. Clearly, if events cause our
expectations regarding inflation to be revised, then the Governing Council remains ready to
act.
Membership of the euro area has given us significant advantages, for example, in relation to
liquidity support to our banks and elimination of exchange rate risk within the euro area. The
advantages can also be seen by the fact that debates are now taking place in countries
outside of the euro area regarding the benefits membership could bring them. However,
membership of a monetary union and the absence of an independent monetary and
exchange rate policy means that member state's domestic economic policies have to be
appropriate. In particular, as I have mentioned earlier, in the absence of an independent
monetary policy, it is essential in present circumstances that a strong focus is placed on
policies to restore competitiveness.
Contributing to financial stability
While monetary policy and liquidity provision have always been the key functions of central
banks, in recent years there has been an increasing emphasis on their contribution to
financial stability.
Through the publication of financial stability assessments, central banks in the major
industrial countries draw attention to risks to the financial system. This information and
analysis is provided to the wider public, financial market participants and directly to the banks
so that they are informed about the economic and financial environment, thus allowing them
to adjust their behaviour consistent with those risks.
It is precisely this role that the Central Bank here has played over the past four to five years
pointing out the domestic and international risks to the economy at a time when house prices
and credit growth were increasing at very high rates. These risks, based on our ongoing
analysis and research, were highlighted not only in our annual Financial Stability Reports, but
also in our Quarterly Bulletins and in statements made by me regularly. In the context of an
unprecedented period of expansion and wealth creation, this proved a difficult message to
get across. It is evident there was not a sufficient or timely change in behaviour in response
to these warnings. Other central banks around the world faced similar headwinds in changing
behaviour consistent with the risks identified in their own financial stability assessments.
An international debate has now begun on how authorities might directly change the
behaviour of financial market participants to mitigate the risks identified in Financial Stability
Reports. This debate, in part, is focusing on whether central banks need specific powers to
intervene directly in this regard. For example, one proposal is that central banks might have
an explicit role in setting capital ratios in response to emerging risks identified in their
financial stability assessments.
A further area for discussion is how monetary policy might better respond to asset price
developments. For example, should policy "lean against the wind" by tackling asset price
inflation more directly.
Recent developments
In late-September, following the Lehman's bankruptcy and when the global interbank
markets froze and funding was unavailable even at the shortest maturities, the Central Bank
formed the view that the risks to financial stability were becoming unacceptably high with
knock-on effects for the wider economy. The scale of liquidity outflows was such that some of
our institutions had acute liquidity risks. The concentrated nature of the Irish banking system
meant that there was a high risk of contagion in the event of an individual bank encountering
difficulties. There was no impending pan-European initiative to address these international
pressures at that time, although it was to emerge subsequently. Our own Government
decision to guarantee key liabilities of the banking sector was taken at that time to protect the
stability of the domestic financial system by ensuring renewed access to funding for Irish
financial institutions. A success of this measure was evident by the immediate improvement
in the liquidity situation, including a substantial net inflow of funds in the days after the
guarantee was introduced, and the ability of a number of the covered institutions
subsequently to raise longer-term finance on the international markets. In the subsequent
weeks, most other European countries moved to introduce some form of guarantee
arrangements.
It was recognised at the time that it would also be necessary to determine if additional capital
was required, particularly in the context of demands for higher Tier 1 capital by international
investors and pressure on property valuations in the context of a much more significant
downturn. Accordingly, after consultation with the Central Bank and the Financial Regulator,
the Government announced details last month of its capitalisation scheme. The risk for banks
that do not meet higher market standards is that they face a much more difficult environment
for raising funds. It was not acceptable to the authorities that banks would attempt to achieve
these higher ratios by curtailing credit to the real economy. A very important aspect of the
capitalisation scheme is the agreement of the participating banks to develop specific credit
policies targeted at small and medium sized enterprises, first time buyers and consumers
generally.
As part of the response of the authorities to ongoing events, the Government last week made
its decision to bring Anglo Irish Bank into full public ownership in order to secure the bank's
continued viability. The action was in response to a weakened funding position and the
reputational damage to the bank arising from unacceptable practices that took place within it
at a time when overall market sentiment was already negative towards the institution. It
meant that recapitalisation was no longer the appropriate and effective way to secure its
continued viability. So far as Allied Irish Banks and Bank of Ireland are concerned, the
Government has reiterated that it sees these banks as central to the Irish financial system
and essential to the proper functioning of the economy. It has also indicated its intention that
both banks remain as independent banks in private ownership and has stated that it is
proceeding with the planned re-capitalisations of both banks.
A well functioning financial system is central to the well-being of any economy. The
Government has underlined the strong commitment of all the authorities to take whatever
action is necessary to achieve this outcome.
Amando M Tetangco, Jr: Sustaining partnerships in a year of challenges
Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines
(Bangko Sentral ng Pilipinas), at the Annual Reception for the Banking Community, Manila,
16 January 2009.
* * *
Members of the judicial, legislative, and executive branches of government; leaders of the
Philippine banking community; special guests from the diplomatic community, the private
sector, the academe, and the media; fellow central bankers; ladies and gentlemen, a
pleasant good evening to all of you.
On behalf of the Monetary Board, I thank you all for taking the time to join us tonight for our
traditional Reception for the Banking Community.
That we are celebrating 60 years of Central Banking in the Philippines in 2009, makes this
reception doubly meaningful. We are happy therefore that we have with us tonight former
deputy governors and members of the Monetary Board; two former governors under the
Central Bank of the Philippines - Governor Jaime Laya and Governor Jose Cuisia, Jr.; and
one former governor of the Bangko Sentral ng Pilipinas - Governor Gabriel Singson. Ladies
and gentlemen, let us acknowledge all central bankers - past and present - on this 60-year
milestone with a round of applause.
We have 60 years of central banking behind us and we move forward to the future with
confidence having learned many lessons along the way. We therefore look forward to more
opportunities for us to shape a better future for ourselves, our families, our communities, and
our country through sound and responsive monetary and banking policies.
Take the year just past, for instance. No doubt about it, 2008 was challenging given the
difficulties we had to face. But it was also the same difficulties that allowed us to confirm..
that our collective reform efforts have put our financial system in better shape.
Indeed the irony of financial markets is that crises invariably occur despite the best
intentions; yet, it is in facing the next challenge in relative strength that we can truly say we
have learned from the past.
Ladies and gentlemen, we are fully cognizant of the difficulties that the current global
financial crisis has created and the spillover effects that it would certainly generate. Our
continuing efforts to clean up our domestic banking system and root out malpractices that
particularly victimize the most vulnerable customers and our financial safety nets may also
be creating short-term anxiety alongside global turmoil.
But I stand before you tonight to affirm that our banking system, in all its vital components -
rural and cooperative banks, thrift banks, and commercial and universal banks, is in much
better shape today than it was during the last crisis we faced. And I can tell you, the
Monetary Board and the rest of the Bangko Sentral ng Pilipinas family remain confident that
our banking system can work through these challenges.
I assure you, this is not meant to be a self-acclamation. Rather, it is our tribute to the
collective efforts we have invested in our shared future. As a community of stakeholders, it is
this common future that requires of us.. shared responsibilities to take on challenges together
in order to grow and gain as one. I refer specifically to the Bankers Association of the
Philippines, the Chamber of Thrift Banks and the Rural Bankers Association of the
Philippines. The Bangko Sentral ng Pilipinas thanks you and salutes your efforts in
sustaining economic activities not only in urban centers but also in the countryside through
responsible and responsive banking. Ladies and gentlemen, let us give a round of applause
to the Philippine banking sector.
There is a saying that it is okay to build sand castles in the sky for as long as our feet are
well planted on the ground. What is the context, what do I mean by this? There are three
points I wish to make.
First, the best strategy is always to move forward as one. This is not an inspirational punch
line but the hard reality of market dynamics. We appreciate that banks are inherently
business concerns, but protecting the institutional bottom line requires nurturing sustainable
relationships in a thriving environment. What is not too obvious is that the financial system as
a whole moves forward only when we work together. Ultimately, it is this stability from
working together that gets us through the business cycles, even as this starts from a position
of competing interests. As competitive elements within one system, we can always agree to
disagree but we cannot fall into the trap of disagreeing to agree.
Second, it is critical that any lingering risk aversion from whatever source does not spill over
into our ability to provide needed financial services for our real economy. Global conditions
will be challenging. But in the same breath, let us not allow fears of off-shore conditions to
pre-judge our on-shore actions, when and where such links are not warranted. If we are to
consolidate our position of relative strength, we need to seize opportunities when they
present themselves, while mindful of our basic fiduciary responsibilities and our mandate to
act prudently.
This is a call for active participation at a time when the real economy needs us the most. We
have seen how successful partnerships between the Bangko Sentral and the banking sector
generated positive results for our people, our economy, and our country. I refer specifically to
the banking sector as effective and responsive transmission channel for the Bangko Sentral's
policies concerning money, banking and credit.
And now, to pro-actively move forward, I also ask for a re-affirmation of our partnership
across a spectrum of initiatives - from expanding access to and improving the quality and
cost of our services especially to the poor, to small enterprises, and to our overseas Filipinos;
to building and deepening financial awareness and literacy; to promoting better consumer
protection; to structuring organized and transparent financial markets. The times are
challenging but they are as much a test of our own resolve; this will prove to be the first
hurdle in building sustainable relationships in a thriving environment.
Third, the global financial architecture is broken because less attention was given to the
details as markets moved faster, forward, and further. There was over reliance on market
pressures to instill market discipline and global institutions - from multilaterals to regulators
to market players - took comfort from the on-going work on best international practices. As
we are now reminded, market failures happen at a painful cost to the displaced and that best
international practices will mitigate domestic risks only if the supervisory framework evolves
with market dynamics.
Moving forward, I believe that the need is not necessarily for more complex and rigorous new
regulations but for greater accountability. Much more would therefore be required of the
Board of Directors of banks and of the technical expertise of the line functions that relate to
prudential management of risks. This is the form of market-driven accountability that I believe
will be needed in restructuring the financial landscape - and it is quite different from just
simply having more regulations. Let us therefore work more closely together in crafting
regulations that would make markets more efficient and dynamic.
Will 2009 be a difficult year? Given the downward trajectory of the global economy, volatile
commodity prices, and the continuing financial turmoil, conventional wisdom says that it will
be.
Nevertheless, I believe that together we have the capacity to ride out the challenges before
us. The key is to manage the factors that are within our control, to maintain a positive
mindset, and to capitalize on our time-tested resiliency and ability to innovate amidst
challenging times.
And don't forget, our economic fundamentals continue to be a source for optimism. This
includes sustained economic growth, slowing inflation, declining interest rates, record high
international reserves, balance of payments surplus, a competitive peso and a stable
banking system.
In the end, the challenge in 2009 for the banking sector is to quickly act on the painful
lessons of the global financial crisis. It is simply far too convenient to point at the complexities
of structured products, the over-leveraging, or the fundamental dilemma with market greed.
All these were necessary inputs but together they are not sufficient to explain where the
world is today. More importantly, debating the whys and wherefores will have its place, but at
this juncture we need to act decisively with conviction, in unison, and move forward.
Ladies and gentlemen, while the global prognosis for 2009 is daunting, the Bangko Sentral
continues to believe that the Philippines remains in a position of relative strength as we
navigate through these difficult times. What we do to consolidate our gains rests squarely on
us. In the case of the Philippine banking community, I am confident it will prevail and remain
sound and stable.
On behalf of the Members of the Monetary Board, I thank all the sectors represented here
tonight for their continuing support: the banking community; the legislative, executive and
judicial branches of government; the private sector, the diplomatic corps, the academe, the
media, our special guests, and our partners in bilateral and multilateral agencies.
Together, let us offer a toast to our continuing partnership in sustaining economic growth in
our country and improving the quality of life of Filipinos. Cheers!
Finally, before it becomes totally unfashionable, let me take this opportunity to wish all of you
blessings of good health, success, and prosperity this New Year.
Mabuhay!
Thank you all and enjoy the rest of the evening.