Yves Mersch: Interview in Luxemburger Wort
Interview with Mr Yves Mersch, Member of the Executive Board of the European Central Bank, in
Luxemburger Wort, conducted by Mr Pierre Sorlut and Ms Barbara Tasch on 8 March and
published on 14 March 2018.
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Mr Mersch, the Governing Council has not yet decided to raise the interest rate. When
that happens, the debt-to-service ratio will increase and put pressure on households
who took out loans to buy their houses. How big is the danger?
Let me say first that the bigger the imbalances, the less the economy is prepared for a monetary
policy change. Any change in the monetary policy stance is always a shock to the economy,
positive or negative.
It's not in our mandate to consider the households of any particular country when we change the
monetary policy stance. That includes Luxembourg. We set interest rates for the euro area as a
whole. We are not yet ready at this stage to change interest rates. We first take the
nonconventional measures towards the exit. Only then will we consider the conventional ones.
Today, at our press conference, we confirmed that we're confident with the path which is leading
to our objective. The primary objective is price stability, which we have defined as an inflation rate
of below, but close to, 2% in the medium term.
Second, on some banks' balance sheets, loans to the private sector are very substantial and in
some there is a high concentration of mortgages. In Luxembourg there are one or two institutions
that rank among those with the highest exposure to mortgages in Europe. If a shock affects this
cluster of assets, then they are at risk. Household indebtedness in Luxembourg is higher than in
other countries - however the wealth of these households is also higher than in other countries,
and disparities between the holders of assets and liabilities also have to be considered. What is
specific to Luxembourg is that the price pressure on the housing market is growing faster than in
many other countries. We're speaking of a 7% increase while the economy is growing at only
half that rate. We're speaking of a more than 50% increase in house prices over the last eight or
nine years. This is mostly explained by the insufficient supply and by the strong demand resulting
from labour inflows. This also results in wealth per capita in Luxembourg not growing. In turn, that
creates the impression that wealth is not being fairly distributed. To sum up, Luxembourg is not
running into a wall but risks are clearly there and actions have to be taken, as recommended by
international and domestic institutions.
What actions?
That's up to the national authorities. It's not a matter of monetary policy. Monetary policy is a blunt
weapon. But those best equipped to deal with the situation are the national authorities, as they
are the closest. This is why macroprudential policy, as it is called, is in the hands of the national
authorities.
What would be the room for manoeuvre?
There are tools which are aimed at the borrower or the lender. You have debt-to-income ratios,
loan-to-value ratios, etc. There are also tax measures. If, on the one hand, you support lending by
reducing taxation, it makes no sense to tighten lending with macroprudential tools on the other.
One has to be consistent.
Being consistent is the first rule of governance. If monetary policy is loose, as it is now, and on
top you also have loose fiscal policy, and on the supervisory side you deregulate or have very lax
supervision, then you're asking for trouble. That's exactly what caused the last financial crisis:
the combination of loose fiscal policy, accommodative monetary policy and lax supervision.
How exactly does the ECB assess the risk of Brexit?
First, we need to know what the UK is requesting. Second, we need to know what is happening
during the transition period - if there is one. If there is no deal and there is a hard Brexit, this will
harm both sides. There will be a need for some legal clarity. For instance, will contracts still be
valid and, if so, how could they be implemented? The private sector solutions could be extremely
difficult and cumbersome. But there could also be a need for a public sector response, e.g.
some recognition or grandfathering of existing contracts. When do you start this grandfathering?
At the moment they declare Brexit or at the moment you start the transition? This is all unclear. I
can't give you all the answers, but neither am I one of those who believe that the EU will go under
without London.
How would you define your cooperation with the Luxembourg regulator?
I consider that the central bank side is working better because it is constructed differently. We
are a Eurosystem, while supervision is not. For the supervisors there are still a lot of national
regulations to respect. If a supranational body like the Single Resolution Mechanism (SRM) were
to use only European law, things would be clear. That would be our preference. But in
supervision sometimes national law prevails and there is still a lot of divergence between national
laws that the single supervisor has to respect.
How would you centralise the whole thing?
Different agencies exist, such as the European Banking Authority (EBA), the European Securities
and Markets Authority (ESMA) and the European Insurance and Occupational Pensions Authority
(EIOPA). But they only have what is essentially a coordination role at the moment. The Single
Supervisory Mechanism (SSM) at the ECB has the effective supervisory function for banking. For
all the agencies, there are proposals for improvement on the table. For securities markets,
another important piece of draft regulation is the European Market Infrastructure Regulation 2
(EMIR2). If we have to contact 25 different regulators or supervisors in order to get a picture of
who and what in the single market is allowed and under what conditions, it would be extremely
cumbersome. From that point of view, we welcome an increase in efficiency at European level.
We consider the completion of the banking union important for the single market and the single
currency, in other words, one market, one banking supervisor and one security supervisor in the
medium term. That should be accompanied by one deposit insurance system as well. But I
understand those who say, "Let's first clean up all the remaining negative elements from the past
before we accept a sharing of responsibility at European level. That is exactly what we are doing
now by pushing for the resolution of non-performing loans. We're trying to put supervisory
standards on the same level. It is not enough to assign only the responsibility to the European
level, we also need a level playing field in terms of the tools and their implementation.
1
The Commission de Surveillance du Secteur Financier (CSSF) has recently expressed
its concern about its sanctioning powers. What do you think of Director General Claude
Marx's statement?
I don't know this statement. According to European law, the authority for criminal cases is still a
national affair. When it comes to administrative sanctioning, that's another issue. Some propose
setting up a sanctioning authority that does nothing but sanctioning. I don't know, and I do not
have to know, national initiatives in a national context in this respect. On the central bank side we
have sanctions at national but also at European level.
You're referring to the case of the Latvian bank ABLV...
The Latvian subsidiary. I read in the media that the supervisory side of the ECB informed the
national authorities of what happened and suggested to them to use the tools they have at their
disposal. Since the way the national tools were used is now the subject of a court case, I cannot
comment further on it. Let the court decide. The national central bank for its part took its own
measures. And they suspended the bank. The ECB did not suspend the whole group [from
monetary policy operations] until later. The Banque centrale du Luxembourg (BCL) suspended
the group before the ECB because they have the possibility to do so at national level.
Would you have another example?
There are some investment funds which ought to provide information and statistics to the
national central bank, which then reports to us. But some funds don't do it. We have asked the
BCL several times to initiate sanctions because we consider that the local authority has clear
knowledge of the matter. I think they are now ready to do it. I would not say centralisation is better
per se. Sometimes proximity leads to higher efficiency.
Another topic which is concerning the ECB and national lawmakers is virtual currencies.
Luxembourg and other countries in the EU are granting more and more importance to
virtual currencies, but you seem to be really cautious. What do you see as the biggest
potential threats emanating from cryptocurrencies?
One should consider various aspects. One is financial stability, the second is consumer
protection, the third is investor protection, the fourth is market integrity and the fifth is anti-money
laundering. Concerns regarding these aspects are especially high in relation to what you call
cryptocurrencies. I call them virtual tokens, by the way. They are like the tokens you buy when
you go to a casino. Studies have shown that 50% of transactions made using these virtual
tokens and 25% of users are linked to illicit activities. There are four main risks. The first risk is
market liquidity. The market is excessively concentrated, with about 96% of transactions being
carried out by 2% of account holders. Second is liquidity risk. These currencies still always need
transferring to the real economy because your bakery will not accept them. There were
conferences on bitcoins where they said you could pay with bitcoin. But when you tried to pay the
entrance fee with bitcoin, it took so long that the conference was over by the time the payment
was received. It is not an efficient system.
The third risk is that people use cryptocurrencies to create leverage because they don't get
leverage any more in the real economy. For example, consumers could use their credit cards to
make such investments and increase their indebtedness. The higher the leverage, the greater
the risk as well.
The fourth risk is the operational and technical immaturity of the technology. We are open to the
technology of distributed ledgers. But that is something different from bitcoin. Bitcoin itself
belongs to no one; no one is backing it, no one is issuing it. The mining is happening to a large
extent in remote places and involves very high energy consumption. Bitcoin's estimated annual
energy consumption has now reached more than 52 terawatt hours per year, which is more than
the total energy consumption of Portugal. We see that, for example, when approval is sought, it
sometimes takes several hours to get one block validated. The ECB, by contrast, is about to
offer instant payments in all European countries. An instant payment costs 0.2 cent and the
recipient has it within 10 seconds. This is efficient and pan-European, and it is also operated by
trusted authorities as well as regulated and supervised entities.
Then you have contagion channels for the risks of virtual currencies. If households are heavily
involved in bitcoin and the whole thing collapses, it could create a wealth effect on the economy,
depending of course on the scale of the market. With official currencies, you have central banks,
like the ECB, you have governments who put political capital into maintaining a currency and
supporting it. But if people do not distinguish between the two things - and this is why I don't like
the word "currency" for these schemes - it would undermine confidence in the official currency.
And some of those who promote these new schemes want a currency which is not controlled by
a government. So it's a slightly sympathetic anarchic or libertarian approach, but unfortunately
there is no libertarian law enforcement and there is no libertarian world government.
You said in London last month that virtual currencies were not real money and that they
wouldn't be for the foreseeable future. So what would have to change for them to be
considered money, what would need to be implemented?
Without a trusted authority backing the stability of a so-called currency, an institution whose
primary objective is to do just that, you don't have a currency. A currency has three functions: a
unit of account, a store of value and a medium of exchange. These tokens don't fulfil any of the
three functions, as I said in London.
There is another sector growing without proper authority, and that's shadow banking. A
recent study has shown that it's growing, and that the Luxembourg market - which is for
the first time included in the study - could represent 7.2% of all shadow banking. How
would you judge whether activities like securitisation represent a threat to financial
stability?
Let me first say that you cannot call everything that is not a bank a shadow bank. Banking by
definition means that you give credit and you take deposits. Indeed, many of these institutions
don't do that. But on the other hand it is certainly true that some vehicles have been created to
remove risk from banks and thus reduce their regulatory capital requirements, with such vehicles
being used in order to escape supervision. That is what we cannot accept any more. We cannot
afford another crisis of the magnitude we had.
How would you manage that risk?
We need to be determined and implement the rules that were agreed at the Pittsburgh G20
summit. But not everything is shadow banking. For example, the World Bank - and above all its
sister organisation the International Finance Corporation (IFC) - is doing a lot of financing through
Luxembourg. All the international development banks are issuing through Luxembourg because
of its efficient legislation. Many corporations which operate worldwide cannot raise funds in each
country; it's more efficient to bundle them. I would say that this is efficient international finance,
not shadow banking, and it does not create additional risk for the customer but rather lowers the
cost of funding.
Another topic for discussion is money market funds, which to some extent can have leverage
and so are much closer to being like a bank. And that is also the reason why money market
funds are obliged to report to the ECB. Then you have investment funds from entities like
investment banks, private equity and other alternative investment funds (AIFs). Don't forget that
Lehman Brothers was not a bank in Luxembourg, but they sold their products to most banks at
that time. So these are areas where we have to see whether what's involved is not in fact a
banklike activity. And if it is, then it should also be subject to the same regulations as a bank, because
otherwise we don't have a level playing field. The objective is to de-risk the financial world and
prevent the kind of risk accumulation that led to the crisis. We should regulate risk rather than
entities according to their legal definition.
How much of a risk are the Italian election results to financial stability in Europe?
Italy is the third largest economy in the euro area. Italy has shown a certain amount of institutional
resilience in the past, and of course the elections have been a lesson to the established parties. I
hope that resilience will come into play in the coming weeks and months.
And then on the other side of the Atlantic, President Trump has just announced an
increase in tariffs on steel and aluminium, which could start a trade conflict with Europe.
How much does the ECB worry about that?
Obviously, conflicts are not conducive to economic growth, but let's take things step by step. As
the President of the ECB said at our recent press conference, they can affect the confidence
channel. This is because confidence is so important, even at this stage of the economy's
expansion.
Some forecasts have shown a slight slowdown in growth in the euro area. How could
that become a problem for the inflation target?
Less than six months ago, some said that inflation would be below 1% in February or March, and
growth forecasts were less than half of what they are now. All the indicators point to economic
growth in Europe continuing, because, for example, both capacity utilisation and labour utilisation
point to a continued need for further investment and capacity extension. Supply-side expansion is
increasing potential growth and allowing for more labour utilisation and higher incomes.
To conclude on a more personal note, what are your plans for December 2020?
I couldn't even tell you where I will be spending Christmas 2020, and I have not given it any
thought. Indeed, I still enjoy my work. But the older you get, the more you are unable to make
plans which are 50 years ahead.
1
The Commission de Surveillance du Secteur Financier is the supervisory authority of the Luxembourg financial
sector.