Ewald Nowotny: Real implications of the financial turmoil - strategies for
growth and stability
Keynote Speech for Panel Discussion by Mr Ewald Nowotny, Governor of the Austrian
National Bank, at a conference, hosted by the Representative Office of the Austrian National
Bank in Belgium, Brussels, 20 January 2009.
* * *
Financial turmoil and its impact on the Austrian banking sector
•
As you all know, global financial markets have been shaped by financial turmoil
since the summer of 2007. In September 2008, the crisis intensified as
uncertainty in international markets was raised considerably when Fannie Mae and
Freddie Mac were placed under conservatorship, and when Lehman Brothers -
which had been a major counterparty in the credit derivatives and swap market -
went bankrupt. The uncertainty was further heightened by massive write-downs and
liquidity problems of large international banks and insurance companies. Stock
prices plunged, credit risk premia rose substantially, and conditions on the interbank
market tightened even further.
•
In this situation, central banks and governments responded with numerous
in the financial market. In the EU,
measures to restore confidence and stability
the heads of state or government endorsed a joint action plan to fight the financial
crisis by raising the savings guarantee for depositors, recapitalizing financial
institutions and guaranteeing certain bank obligations. Austrian policymakers also
adopted comprehensive measures to fight the financial crisis.
•
Although the direct effects of the financial crisis on Austrian banks have been limited
so far due to their relatively small exposures to the U.S. subprime market, Austrian
banks have been indirectly affected to a significant extent as refinancing costs
rose, income declined, loan loss provisions had to be raised and risk aversion
increased among investors especially towards exposures in Central, Eastern and
Southeastern Europe (CESEE). However, Austrian banks expect net income to
have been still clearly positive in 2008 - as of the 3rd quarter 2008 they expected a
net income of EUR 3.6 billion for 2008, which is 25% down compared to year-end
2007; additional write-downs expected in the 4th quarter will, however, have
depressed income even further.
•
Regarding foreign currency loans, which are very popular in Austria, the share of
foreign currency lending to customers decreased over the last years, although it is
still high on an international comparison (18% of total loans to domestic customers
in Q3 2008). In 2008, the developments on foreign currency markets (e.g.
appreciation of the Swiss franc and the Japanese yen against the euro) had a
negative impact on outstanding FX volumes. Due to this increase in FX risk, most
banks announced more restrictive allocation policies for the future, and the Austrian
authorities increased their monitoring activities of these loans.
•
Austrian banks were first movers in the CESEE banking markets in the late
1980s.Since then they have continuously expanded their presence and are now
significant players with highly diversified exposures across the whole CESEE
region.1 According to business segment reports, the largest Austrian banks
generated consolidated profits of EUR 3.3 billion in the first half of 2008 in CESEE,
compared to EUR 1 billion in the domestic segment and -EUR 0.3 billion in the rest
of the world. In recent months, the global economic slowdown has also led to
increasing vulnerabilities in CESEE, especially in Hungary, the Ukraine and Latvia;
and the risk aversion of global investors towards this region has increased. In
addition, local banking systems are quite exposed to foreign exchange risks given
the high share of foreign currency loans.
Austrian measures to combat the financial crisis
•
The measures adopted by Austrian policymakers to fight the financial crisis were
endorsed by the Austrian Parliament in October 2008 and encompass primarily two
new laws, the Interbank Market Support Act (InterbankmarktstärkungsG), and the
Financial Market Stability Act (FinanzmarktstabilitätsG).
•
The Austrian measures were designed in accordance with the common principles
highlighted in the Ecofin meeting on October 7, 2008, and the Declaration on a
concerted European action plan that the heads of state or government of the euro
area made on October 12, 2008.This declaration, which defines specific
cornerstones regarding national measures for supporting the financial markets,
shows that the European Union is in the position to act quickly and coordinated in
the case of a financial crisis.
•
With the Interbank Market Support Act, an "Austrian Clearingbank"
(Oesterreichische Clearingbank AG) was established as a special purpose entity for
strengthening the inter-bank market. The Austrian Clearingbank serves as an
intermediary on the interbank market by borrowing funds and lending such funds to
credit institutions and insurance undertakings. The Republic of Austria assumes
limited-term liability for receivables and a guarantee for debt instruments issued by
the Clearingbank. Measures under this law may not exceed EUR 75 billion and
they are temporary - the law expires on December 31, 2009.
•
Under the Financial Market Stability Act, the Minister of Finance may take
measures to recapitalize credit institutions and insurance undertakings by way of
assumption of liabilities, guarantees for loans and provision of own capital,
acquisition of company shares or convertible bonds, takeover of company assets,
and - as last resort - takeover of property rights (i.e. nationalization).Fees and
interest for the instruments must be set at market rates. Measures under this law
may not exceed EUR 15 billion. The law also provides for (re)privatization after the
purpose has been achieved.
•
Another measure taken by the Austrian authorities concerns the safeguarding of
bank deposits:
•
For bank deposits of retail customers, a 100% state guarantee was put in
place retroactively from October 1, 2008, limited until the end of 2009.
•
As of January 1, 2010, protection for retail customers will be raised to EUR
100.000 (previously EUR 20.000 per account holder/per bank).
•
The deposit protection for small and medium-sized enterprises will be
raised to EUR 50.000.
•
A maximum of EUR 10 billion is allotted to this measure.
•
In addition, the Austrian Financial Market Authority (FMA) passed a decree
prohibiting the short-selling of the stocks of insurance companies and banks listed
on the Austrian Stock Exchange, for a period of 3 months until the end of January
2009 (which can be prolonged if deemed necessary).
• All these measures, adopted in a swift and comprehensive way, will contribute to
reestablishing confidence in the Austrian financial market and securing financial
stability.
Development of the European supervisory framework
•
The current financial crisis has revealed certain weaknesses in the EU's
which is still fragmented nationally despite increasing
supervisory framework,
financial integration and cross-border activities of financial institutions. Until now the
supervisory development in the EU has followed an evolutionary approach, and the
Level 3 Committees of the Lamfalussy Framework - CEBS, CESR and CEIOPS2-
have achieved considerable convergence regarding supervisory practices and
procedures. However, the weaknesses revealed in the course of the financial crisis
have prompted supervisors and regulators on international as well as EU levels to
rethink the supervisory framework and come up with proposals for strengthening the
current architecture.
•
From my point of view, strengthening the role of the consolidating supervisor
as originally proposed in the amendments of the Capital Requirements Directive
(CRD) is not the right way forward in developing EU supervisory regimes. The
strengthened consolidating supervisor, or "lead supervisor," would hinder the
development of an EU-wide supervisory approach, and lead to group-specific and
fragmented supervisory regimes. Credit institutions would be faced with an unlevel
playing field, since they would conduct business on the same local markets but be
subject to different supervisory regimes. Moreover, the lead supervisor approach
would not take into account the interests of local supervisors and governments. The
local entities would be supervised by a foreign authority with very limited incentives
to provide information, while responsibility for financial market stability would remain
with the local authorities. These are not favorable preconditions for effective crisis
management and resolution.
•
Thus, I would suggest to further optimize the current supervisory framework in
the short term, building on the improved supervisory colleges, and further promote
regulatory convergence. However, in the longer term, the only feasible concept,
from my point of view, is the establishment of a federally organized European
System of Banking Supervisors. This seems to be the only way to ensure real
supervisory convergence as well as efficient and effective supervision of
crossborder institutions. In such a system, a European Banking Supervisory Authority
should act as regulator and take all supervisory decisions on cross-border banking
groups. At the same time, and coordinated by the European Supervisor, the
factfinding in terms of on-site inspections and off-site analyses should remain at the
national level. This would ensure that supervisors have local market knowledge. For
banks that are predominantly active at the national level, the national authorities
would keep their current responsibilities. This would not only prevent an
overburdening of the European Supervisor, but also be consistent with the principle
of subsidiarity.
•
However, the move to such a system requires a strong political commitment and
probably also stronger political integration; moreover, a number of preconditions
especially with respect to burden sharing arrangements would have to be fulfilled. I
would therefore suggest establishing some kind of "Masterplan", a roadmap
towards a European System of Banking Supervisors with defined milestones and
timelines.
Necessity of coordinated stimulus packages
• The financial crisis has become an economic crisis. Consumer confidence is rapidly
decreasing, and growth forecasts for industrialized countries have been revised
downwards several times during the last weeks. We expect Austrian GDP to shrink
by slightly less than -1% in 2009, which means a downward revision of about 2.5
percentage points since the official June 2008 forecast of the OeNB.3 Forecasts for
Germany are between -2% and -3%. Italy continues to struggle in growth terms;
about -2% are expected for 2009.4 Even world growth is going to be below +1%
(recent projection by World Bank of +0.9% for 2009).
• In "normal" times, fiscal policy supports monetary policy in smoothing the business
cycle via automatic stabilizers. This concept has worked quite well over the last 25
years. However, we do not live in normal times at present: Due to the financial crisis
and due to very low expectations on returns of possible investments for the near
future, the ability of monetary policy to boost investment and consumption is very
limited right now. We seem to be already in an investment trap and might fall into a
liquidity trap as well. So there is a need for fiscal policy measures.
•
Automatic stabilizers still work but are not large enough to prevent a severe
economic downturn. The leeway of automatic stabilizers has been diminished
through structural reforms like reductions in the progressivity of tax systems and a
decrease in the relative size of governments.
•
So coordinated discretionary measures as proposed in the European Economic
Recovery Plan are necessary. Coordination among EU Member States is important
due to their high openness, as a result of which multipliers are relatively low. Most
EU countries (including Austria) are already implementing such programs. In
Germany, the coalition just agreed on a EUR 50 billion package last week.5
•
The importance of discretionary fiscal policy in the current environment has also
been recognized by the IMF, as pointed out in a recent staff position note.6 They
also call for timely and collective measures. The measures should be "lasting"
because the downturn might be lasting, and "contingent" because it might get worse.
So there has to be commitment to keep the measures until the recession is over,
and to do more if the recession gets worse indeed.
•
"Sustainability" of the measures is very important as well. They should not conflict
with long-term goals of growth policy, such as the objectives of the Lisbon Strategy;
this point has been heavily emphasized in the European Economic Recovery Plan.
Furthermore, in accordance with the Stability and Growth Pact, there has to be a
commitment that consolidation will be carried out in better times. Trust of investors
in the sustainability of public finances is crucial to keep financing costs low, and trust
of the general public is important to prevent compensatory private savings in a
Ricardian-like reaction to stimulus programs. The latter point has been emphasized
in a paper in the IMF World Economic Outlook on the effects of discretionary fiscal
policy.7
•
Both the IMF and the EC call for diversified packages combining revenue and
expenditure measures. Spending measures generally take longer to implement but
have also a higher multiplier (which is, incidentally, also the assumption on which
the new chair of the Council of Economic Advisors in the US8 has based its
assessment).
•
Tax cuts and transfers should be targeted to households with a large marginal
propensity to consumption. One possible measure in this context would be to
increase the size of unemployment benefits and the corresponding period of
entitlement. This would also increase the degree of automatic stabilization.
Relatively recent papers by Solow and Blinder9 made some interesting proposals
how to raise the degree of automatic stabilization without increasing the (structural)
size of the government sector (e.g. tax rates responding automatically to the
business cycle).
•
Furthermore, it is important that enterprises belonging to the real economy have
access to credit. The increase of the EIB's credit supply is a step in that direction.
Banks which get capital injections from the Austrian government will be required by
law to use at least parts of the injection to grant credit to SMEs and households.