Christine Lagarde: The European Systemic Risk Board's first general
warning one year on
Welcome remarks by Ms Christine Lagarde, President of the European Central Bank
and Chair of the European Systemic Risk Board, at the 7th Annual Conference of the
European Systemic Risk Board "Financial stability challenges ahead: emerging risks
and regulation", Frankfurt am Main, 16 November 2023.
* * *
It is my pleasure to welcome you to the seventh annual conference of the European
Systemic Risk Board (ESRB).1
Societies throughout history have always found ways to alert people to the potential
materialisation of risks so they have time to successfully pre-empt them.
Some methods were simpler than others. In the Middle Ages, for example, village bells
2
were rung to raise the alarm. But today, the complexity of our economy means that
risks can appear from all angles, and the task of signalling them is often assigned to
expert bodies. The ESRB was set up precisely to identify the risks emanating from an
interconnected financial system that national actors might not see.
Just over twelve months ago, the ESRB published a "general warning" about financial
stability risks, addressed to all European Union and national supervisory authorities.3
This was the first such warning in its 13-year history - and a clear call to action.
One year on, we can begin to take stock of that general warning, with two important
questions coming to the fore.
First, to what extent have the risks that we described materialised so far? And second,
how impactful has the general warning been in increasing the financial system's
resilience?
The materialisation of risks
We issued our general warning in September 2022 - a time of exceptionally high
uncertainty. The Russian invasion of Ukraine had combined with other factors to
increase the likelihood of tail risk scenarios materialising.4
Europe was facing the risk of drastic shortages of gas and oil as winter approached.
And the sharp shift from a decade of very low rates to higher rates in a short space of
time - necessary to fight rising inflation - also risked exposing financial imbalances and
sparking substantial market volatility.
At the time, we warned that all the risks we foresaw could materialise simultaneously
and amplify each other's impact. Fortunately, this scenario has so far not come to pass.
But some specific risks we identified have since partially materialised.
First, we expressed concern that households and companies would see their debt
servicing capacity affected. While employment has remained resilient so far,
households' real disposable income has come under significant pressure due to high
inflation.
Second, we highlighted risks stemming from a sharp fall in asset prices. We saw these
partially materialise with the failure of US-based regional banks, the gilt crisis in the
United Kingdom, and more recently in the price fluctuations of US Treasury bonds.
But there are other risks that have not yet materialised.
We warned that a deteriorating economy could threaten the asset quality and
profitability of credit institutions. Yet EU banks now benefit from higher levels of
profitability than at any point in the past decade. Non-performing loans (NPLs) remain
low, supported by stable employment levels. And residential real estate markets - a key
exposure for banks - have been slowing down but in an orderly fashion so far.
However, our view remains that all relevant institutions will need to continue to take
action to prevent these risks from materialising over the medium term.
Bank profitability will be adversely affected by the rise in funding costs, reflecting higher
policy rates, and by much lower lending volumes. And the enduring combination of low
growth and higher debt servicing costs will continue to strain vulnerable households and
firms, which could see NPLs rising.
Moreover, the list of vulnerable nodes in our financial system remains long - for
example, money market funds and investment funds, notably those investing in illiquid
assets. And channels of contagion could still re-emerge. In particular, the margin
policies of central counterparty clearing houses could amplify stress in the system. EU
banks' holdings of fixed income securities could be marked down quite significantly,
should they need to be sold.
It would be unwise to be complacent. The ESRB will therefore continue to monitor
developments carefully.
The impact of the general warning so far
How impactful has the warning been in increasing the financial system's resilience after
one year?
We addressed our general warning to all EU and national supervisory authorities in the
banking and non-banking financial sectors. These authorities interact frequently with
their supervised or regulated entities, which in turn take thousands of risk management
decisions every day.
This makes it challenging to pinpoint the exact effect of our general warning in this vast
ecosystem. But we can still understand its impact across two dimensions: awareness
and action.
It is precisely because we stand at the heart of this ecosystem that we can create a
broad awareness of the risks that we identify. While by law we could only issue the
warning to public institutions and not to the general public, it was reiterated across this
network.
Awareness has acted as a catalyst for action, too. The warning has enabled
policymakers and supervisors to anchor their decisions to our assessment and has
helped them to push through necessary reforms to their macroprudential and
microprudential policies.
And ESRB warnings also work in more subtle ways, not only as a catalyst but also as
an inhibitor: they may help slow down decision-making and so avert hasty risk
management decisions; supervisors may pause for longer in assessing whether an
institution's vulnerabilities are critical; and policymakers might more strongly resist calls
for watering down legislation.
So our assessment is that the general warning has indeed proved impactful over the
past year. The ESRB's words have clearly worked towards reducing policymakers'
"inaction bias" with regard to the implementation of macroprudential policy.5
On the other hand, our work is not yet finished. But I am firmly convinced that the joint
action of the EU financial stability community at large will be sustained and unwavering,
so that our warning will have helped to avoid damage to the economy.
Conclusion
Let me conclude.
To date, Europe's financial system has avoided the worst-case scenario of severe
systemic risks materialising at the same time. But policymakers need to remain
proactive and alert to financial stability risks as and when they arise. As Abraham
Lincoln once observed, "Leave nothing for tomorrow which can be done today."
And turning to today's conference, I have no doubt it will provide for a stimulating
discussion about how macroprudential policy can help us best tackle the financial
stability challenges that lie ahead of us.
With this, I now open the seventh ESRB conference.
1
Welcome remarks pre-recorded on 14 November 2023.
2
Vögele, W. (2023), "Sounds and Silence: Ringing of the Bells in the Period of
Reformation ", Carillon and Bell Culture in the Low Countries , Vol. 2, Issue 1.
3
ESRB (2022), "Warning of the European Systemic Risk Board of 22 September 2022
on vulnerabilities in the union financial system ", Official Journal of the European Union,
7 November.
As noted in ESRB (2022), "The General Board of the European Systemic Risk Board
held its 47th regular meeting on 22 September 2022 ", press release, 29 September.
5
See discussion in ESRB (2022), "Review of the EU Macroprudential Framework for
the Banking Sector: A Concept Note", March.