Luis de Guindos: Macroprudential policy and research - learning from
challenging times
Dinner speech by Mr Luis de Guindos, Vice-President of the European Central Bank, at
the European Central Bank fifth Macroprudential Policy and Research conference,
jointly organised with the International Monetary Fund, Frankfurt am Main, 17 October
2023.
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It is with great pleasure that we host the fifth ECB macroprudential policy and research
conference, the first one to be held in person since the beginning of the pandemic.
This conference aims to preserve close ties between the research community,
practitioners and policymakers in the macroprudential policy field which, especially in
the euro area, is still relatively young.
From my point of view, the macro-financial challenges we are currently facing certainly
provide a strong motivation to further strengthen the ties between research and policy.
Let me highlight some of the challenges that lie ahead from a macroprudential
perspective and point to some areas where I believe research could support
policymaking in the current environment.
Economic activity remains subdued and is expected to stagnate until year end with risks
tilted to the downside. Inflation is declining but is expected to continue being clearly
above our definition of price stability. Over the past 14 months, we have raised our
policy rate at an unprecedented pace, by a cumulative 450 basis points, and
significantly reduced the size of the ECB's balance sheet, leading to tighter financing
conditions.
In this context, the euro area financial stability outlook is fragile, as the financial system
adapts to a higher interest rate environment. Real estate markets are in a downturn, a
severe one for commercial real estate. So far, most firms and households have not
endured material stress, although it will take some time before the full impact of higher
borrowing costs, high inflation and weak growth is felt. On the positive side, bank capital
positions in the euro area are sound and the results of the stress test carried out by the
ECB in 2023 confirm that the euro area banking system could withstand a severe
adverse scenario.
Experience tells us, however, that banks might be unwilling to use regulatory capital
buffers to absorb losses, opting instead for de-leveraging to preserve capital ratios. This
is because the use of regulatory buffers comes with limitations, for example, to dividend
pay-outs. Here is where macroprudential policy comes to the fore. Certain
macroprudential capital buffers can be released, making capital usable without
limitations, which mitigates the risk of de-leveraging. Therefore, considering the
challenging financial stability outlook, a pertinent question is whether this is the right
time for macroprudential policy to release capital buffers.
In our view, this is not yet the time for thinking about macroprudential capital buffer
releases. Despite the challenging macro-financial environment, banks are currently
resilient and profitable: on average, their return on equity has reached double-digit
figures for the first time since the global financial crisis. While bank lending lost
momentum, there is currently no indication that this is due to banks being bound by
capital constraints that should be alleviated by macroprudential policy. This type of
constraints could emerge, for example, when banks expect broad based asset quality
deterioration and losses. Therefore, in the current context, we expect that a release of
macroprudential capital buffers would not have any beneficial effect on lending. To the
contrary, maintaining existing buffers preserves resilience and trust in the banking
system when risks are looming. It also has beneficial effects on funding costs, and it
incentivises prudent distributions from banks.
Having established that macroprudential buffers should be preserved, the next question
is whether current macroprudential resilience in the banking system is sufficient if
turbulence turns into a storm. Macroprudential policy in the banking union currently
provides a comfortable first line of defence against systemic risk. 13 countries now have
positive rates for the Counter Cyclical Capital Buffer or CCyB, the key macroprudential
buffer explicitly designed for release during periods of distress. The size of the CCyB
has more than doubled since the onset of the pandemic, though from very low levels.
11 countries have positive rates for sectoral or broad-based systemic risk buffers. All
these capital buffers, provide at least some macroprudential counter cyclical
"firepower". In addition, 15 countries have borrower-based measures in place.
The increasing use of the CCyB across countries reflects important lessons learnt from
the pandemic, namely that releasable buffers are a key instrument to reduce
procyclicality and that they should be available in normal times to enhance the ability of
authorities to respond to a wide set of possible shocks. Macroprudential authorities in
several countries have recently increased the flexibility of their CCyB frameworks in this
direction. At the ECB, we strongly support this positive neutral cyclical buffer approach.
With this characterisation of the conjunctural situation, let me offer a few specific
reflections on how research can support policy-making in the face of current challenges.
The first concerns macroprudential capital buffer releases. Deciding the appropriate
timing for the release of accumulated macroprudential buffers is challenging. In our
view, this decision should be linked to clear constraints in the supply of bank credit due
to banks' capital positions. While research so far has focused on broader
macrofinancial signals for capital releases, I see scope to complement this work with analyses
of conditions and banks' behaviour that would justify releases. This would surely help
making capital releases more effective in reducing the pro-cyclical effects of bank credit
in periods of economic distress.
The second reflection concerns positive neutral capital buffers. As I have mentioned,
this approach is increasingly being used across countries, including those in the
banking union. Models to assess the overall benefits of the positive neutral versus a
purely risk-based buffer framework could be very useful in substantiating policy makers'
support for this approach.
Finally, so far, I focussed on macroprudential capital. But this year reminded us that
also liquidity issues can become quickly systemic. On the one hand, we saw shocks to
market liquidity in the United Kingdom last autumn, when price falls in core government
bond markets led to forced selling by non-bank financial intermediaries, and risked
becoming self-reinforcing. On the other hand, earlier this year we saw shocks to funding
liquidity, where deposit redemptions at an unparalleled speed led to the largest ever
bank failures in the United States, and the abrupt merger of a global systemically
important Swiss bank following liquidity outflows.
These episodes are a stark reminder that more efforts are needed to understand and
mitigate systemic liquidity risks. Increased digitalisation and use of social media may at
some point require a review of the design of microprudential liquidity standards for
banks, such as the Liquidity Coverage Ratio. More importantly, the gradual and
systemwide decline in liquidity implies that a macroprudential perspective on liquidity will
become more relevant going forward. In principle, the existing regulation already
provides some scope to introduce liquidity measures for systemic liquidity risk for
banks. In contrast, regulation of liquidity risk in the non-bank financial sector is more
nascent. Recent efforts by the Financial Stability Board to address the liquidity
mismatch for investment funds are a welcome development but more needs to be done
to address the system-wide perspective.
To conclude, research in these areas and beyond is essential for our work and can help
the young macroprudential policy to thrive and grow to full maturity.