Frank Elderson: Family ties - ten years of monetary policy and
banking supervision under one European roof
Dinner speech by Mr Frank Elderson, Member of the Executive Board of the European
Central Bank and Vice-Chair of the Supervisory Board of the European Central Bank, at
the 2024 Annual ECB Banking Supervision Research Conference, Frankfurt am Main,
11 June 2024.
* * *
Like many events this year, the Annual ECB Banking Supervision Research
Conference is celebrating the tenth anniversary of European banking supervision under
the Single Supervisory Mechanism (SSM). Ten years of the SSM also means ten years
of monetary policy and banking supervision living under the same roof. It means ten
years of ECB Banking Supervision existing alongside the ECB's central banking arm
and benefiting from the same shared services that are critical for effective monetary
policy and banking supervision. And one could also say ten years of close family ties
between the experts working in monetary policy and banking supervision, both here in
Frankfurt and across Europe in the European System of Central Banks and the Single
Supervisory Mechanism.
And like all families, ours is unique.
One distinctive institutional feature of European banking supervision is the separation
principle that applies between the ECB's monetary policy and supervisory tasks. The
former targets price stability and the latter strives to keep banks safe and sound. Under
this set-up, the ECB has a Governing Council, which takes monetary policy decisions,
and a separate and independent Supervisory Board. The Supervisory Board proposes
draft supervisory decisions to the ECB's Governing Council, which can adopt or reject
these decisions, but not modify them. The separation principle ensures that each
function is carried out in accordance with its specific objectives and prevents potential
conflicts of interest.
The Governing Council is chaired by Christine Lagarde and the Supervisory Board by
Claudia Buch. In addition, the Supervisory Board has a Vice-Chair who is chosen from
among the members of the ECB's Executive Board. I currently hold this role. And this
comes with the great privilege of being the one person who participates in all the key
decision-making bodies of our unique ECB family, for both monetary policy and banking
supervision.
In my remarks this evening, I will explain how our decade-old ECB family is about more
than just sharing an institution, a roof and a Vice-Chair. Though pursuing different
objectives, our monetary policy and banking supervision functions have several of the
same characteristics: their focus on stability, a commitment to their respective
mandates, their attitude towards risks, and the challenges they will face in the years
and decades to come.
The origins and achievements of European banking supervision
Our common ties can be traced back to the origins of European banking supervision.
The SSM was born out of crisis. In the years leading up to the establishment of
European banking supervision, the euro area economy was struggling to recover from
the great financial crisis and the euro area debt crisis. Financial crises and financial
fragilities led to de-risking and deleveraging, which had negative repercussions on
economic growth and the inflation outlook. Back then, weaknesses in the banking
sector hindered the transmission of our accommodative monetary policy into similarly
favourable financing conditions for companies and citizens. These obstructions to the
transmission mechanism made it much more difficult for the ECB to maintain price
stability.
Ultimately, the persistent weaknesses in the European banking sector led governments
to establish the banking union. In addition to European banking supervision through the
SSM, with a central role for the ECB, the banking union would include a Single
Resolution Mechanism and a European deposit insurance scheme, although this third
pillar is yet to be implemented. One of European banking supervision's achievements
has been the strong culture of cooperation within our pan-European joint supervisory
teams, who use a harmonised supervisory methodology that ensures the same
standards are applied across all supervised banks. This has helped to significantly
reduce risks in the European banking sector and increase the resilience of European
banks.
The efforts of European banking supervision have paid off. This became clear during
the pandemic, which was the first major crisis since the creation of the banking union.
Instead of being sources or amplifiers of shocks like in previous crises, banks proved to
be resilient to the pandemic shock. In fact, they were able to help dampen it by
extending credit to citizens and companies that had experienced a sudden loss of
income. Unlike during the crises that predated the banking union, banks were no longer
part of to the problem, but part of the solution. Of course, it should be kept in mind that
they were able to do so in a context of massive fiscal support to citizens and companies
and accommodative monetary policy.
Sound banks and effective monetary policy transmission
So where do we stand now? Let me start with the positives, but I must stress that these
are no reason to be complacent.
On the banking supervision side, we see that European banks still have robust
fundamentals, including sound capital positions and liquidity buffers. Levels of
nonperforming loans are relatively low, although they have started to increase recently.
Thanks to their generally sound starting position, banks have been able to smoothly
navigate the adverse macro-financial conditions seen since the end of the pandemic,
such as increasing interest rates, geopolitical shocks and the banking sector turmoil in
March 2023.
Meanwhile, on the monetary policy side, we have explicitly recognised the importance
of safe and sound banks for our price stability mandate since July 2021, when we
concluded our strategy review. Specifically, we acknowledge that financial stability is a
precondition for price stability. Moreover, monitoring the transmission mechanism of
monetary policy - including how banks pass on our policy decisions - is a key
consideration when calibrating our monetary policy. We made this very clear in our
communication since we started to tighten monetary policy. In addition to the inflation
outlook and the dynamics of underlying inflation, assessing the strength of monetary
policy transmission is a key element of our reaction function. The safety and soundness
of banks has not only made them resilient to the unprecedented increase in policy
rates, which went from -0.5% in July 2022 to 4.0% in September 2023. It has also
enabled them to pass on our policy rate increases in an effective and orderly fashion,
ensuring that broader financing conditions evolved in line with our monetary policy
intentions. Having said that, pass-through would have even been stronger had there
been tougher competition for deposits in Member States.
From last September up to last week, a period when we kept policy rates on hold, we
saw a continued strong and effective transmission of monetary policy. By keeping
broader financing conditions restrictive, monetary policy has made a major contribution
to bringing inflation back down from high levels. That is why, at last week's meeting of
the ECB's Governing Council, we considered it appropriate to moderate the degree of
monetary policy restriction by lowering our key interest rates by 25 basis points.
Banks have proven resilient, and inflation is continuing its downward trend. You might
therefore expect both sides of the ECB family to be generally content with the progress
made in the pursuit of their objectives in the recent tumultuous years. But we are also a
family that doesn't easily declare victory, is always on the alert, and we warn of
complacency in view of looming risks and lingering fragilities that may affect price
stability and the safety and soundness of banks in the future. This is ingrained in our
family DNA for all our tasks and responsibilities.
Such caution is particularly called for in today's macro-financial environment, which has
been very much in flux in recent years amid changes in the economic outlook,
geopolitical shocks, and challenges related to global heating, nature degradation and
digitalisation. We expect this period of elevated uncertainty to continue, bringing
challenges for both banking supervision and monetary policy. Indeed, the risks and
trends identified in our monetary policy strategy and our supervisory priorities for the
years ahead are very similar.
Common challenges ahead
So what will these challenges in the macro-financial environment imply for our tasks?
First, our objectives will become even more important. Price stability and sound banks
provide an anchor that makes an economy - and therefore a society - more resilient to
shocks. The more frequent and intensive the shocks, the more vital a secure anchor.
For it is in choppy, not calm, waters when a ship truly benefits from its anchor.
At the same time, the types of shock hitting the economy and the financial system will
become more complex to assess. But an accurate assessment is crucial to gauging the
potential risk to price stability or to the soundness of banks, as well as the appropriate
policy response.
Take the example of the ongoing and worsening climate and nature crises. We know
that manifestations of physical risk - like floods, fires, droughts and extreme weather
events - are on the rise. Governments are acting to support the green transition, while
pursuing climate adaptation measures is becoming ever more important. A relevant
question is whether climate and nature shocks can be fully captured by the traditional
categorisation of demand, supply and financial shocks used in most macroeconomic
models. In that vein, my fellow ECB Executive Board member Isabel Schnabel has
suggested thinking about the impact of climate change on inflation in terms of
1
"climateflation", "fossilflation" and "greenflation". Even if such concepts can be mapped
analytically into the more traditional type of shocks, we need to learn more about the
exact mechanisms before being able to draw the appropriate conclusions for monetary
policy.
Something similar applies on the banking supervision side. The Basel Committee on
Banking Supervision has established that climate-related risks translate into the
2
traditional types of risk that banks consider , covering credit risk, liquidity risk, market
3
risk and operational risk, including litigation risk. However, here too, the exact
mechanisms of mapping actual hazards to risks needs to be analysed further to fully
capture climate and nature-related factors in quantifiable regulatory and supervisory
requirements.
These are vitally important questions as global heating, nature degradation and
transition and adaptation policies have a profound impact on the economy and the
financial system. As Supervisory Board Chair Claudia Buch underlined in her opening
address, research has an important role to play in supporting monetary policy and
supervision in respect of these and other major challenges like the impact of
geopolitical risks and the digital transition.4
Some of these themes will feature at this conference tomorrow. And on the monetary
policy side, we recently established a new research network known as Challenges for
Monetary Policy Transmission in a Changing World (ChaMP). The ChaMP network
seeks to revisit our knowledge of monetary transmission channels in the context of
5
unprecedented shocks and structural changes. Through conferences such as this one,
initiatives like the ChaMP network, and many other interactions with the research
community, we seek your inspiration, ideas and insights to address the challenges
facing monetary policy and banking supervision in the future.
Conclusion
Let me wrap up.
Ten years ago, we at the ECB saw our family grow with the establishment of the SSM.
Ten years on, European banking supervision has made great strides in making banks
more robust and resilient. This has helped strengthen the European economy in
general while also enhancing the effectiveness of monetary policy.
In the next ten years, the two strands of our family will continue to pursue their
respective objectives, no matter what challenges may emerge. They will do so under
one roof, in line with the separation principle and united in their commitment.
Thank you for your attention.
1
Schnabel. I. (2022), "A new age of energy inflation: climateflation, fossilflation and
greenflation", speech at a panel on "Monetary Policy and Climate Change" at The ECB
and its Watchers XXII Conference, 17 March.
2
Climate-related risk drivers and
Basel Committee on Banking Supervision (2021),
their transmission channels, BIS, April.
3
On litigation risk, see Elderson, F. (2023), ""Come hell or high water": addressing the
risks of climate and environment-related litigation for the banking sector", keynote
speech at the ECB Legal Conference, 4 September.
4
Buch, C. (2024), "Current challenges in supervision - new challenges for researchers
", keynote speech at the 2024 Annual ECB Banking Supervision Research Conference,
11 June.
5
The ChaMP network recently held its inaugural conference. See Inaugural conference
of the ChaMP Research Network - Challenges for Monetary Policy Transmission in a
Changing World ("ChaMP").