Christian Noyer: A review of the financial crisis
Speech by Mr Christian Noyer, Governor of the Bank of France, at the Hearing before the
Finance Commission of the Assemblée nationale, Paris, 7 October 2008 (updated 15
October 2008).
* * *
1. A number of comments on the developments of the past month
The bankruptcy of the investment bank Lehman Brothers on 15 September 2008 marked a
crucial turning point in the crisis. The direct consequences of this failure, involving over USD
600 billion in assets, appear to have been correctly contained and managed up to now.
Nevertheless, it exacerbated the crisis of confidence, with the following major repercussions:
•
first, interbank markets increasingly seized up, because banks perceived there to be
a rise in counterparty risk. Overnight dollar interbank rates rose to particularly high
levels of close to 7%;
•
second, significant pressure on other money market segments, in particular the US
commercial paper market, where yields on 30-day paper have been climbing since
mid-September to reach levels close to those observed at the end of last year;
•
lastly, the deterioration in the financial position of AIG, the largest US insurer,
followed by its exceptional bailout. A two-pronged rescue plan was implemented: on
the one hand, the Fed made an USD 85 billion loan at a penalty rate of three-month
Libor plus 850 basis points and, on the other, the US government took a 79.9%
stake in the company. This exceptional intervention was necessary because AIG
had engaged in the highly risky business of selling credit protection over the past
few years, which left it vulnerable and very exposed to a turnaround in the US
housing market.
domino effect,
The uncertainty stemming from this situation gave rise to the risk of a affecting
one financial institution after the next. Fears that this effect could be fuelled by price
manipulations and speculation resulted in a restriction of short selling, first in the United
States and then in many other countries including France, the United Kingdom, Belgium, the
Netherlands, Italy, Germany, Austria and Australia.
It was against this backdrop that the idea of an "overall solution" emerged, marking a change
in strategy compared to the case-by-case approach that had prevailed until then. This was
the underlying rationale for the Paulson Plan adopted on 3 October. Three remarks on the
latter:
•
The general idea behind the Plan is for the Treasury to purchase currently illiquid
assets. It aims to rid banks of the bad assets weighing on their balance sheets, and
to eliminate uncertainty about their real value and, in turn, about that of the banks
themselves. Indeed, under the current accounting framework, these assets are
marked to market, which means that any uncertainty about their value affects that of
the financial institutions themselves.
•
The way in which the Plan is to be implemented still remains vague. One essential
aspect is the price at which assets are to be purchased. The setting of such a price
may be driven by two opposing concerns. On the one hand, bolstering banks'
solvency and capital base, which would call for a high price. On the other hand,
minimising the cost for public finances, which would call for a low price and the
intervention would mainly aim to ease liquidity constraints.
•
The consequences for Europe are generally positive. The rapid implementation of
the Plan may help to reduce pressure on markets and restore confidence among
banks. However, it is important to pay close attention to the way in which it is rolled
out. Indeed, by contagion, low prices could lead to further write-downs in the
balance sheets of European banks.
2. A major shift in the direction of public policy
Liquidity problems remain crucial at this stage of the crisis. Interbank markets remain
strained. Central banks have considerable firepower to deal with this. In this respect, a wide
range of actions has been taken over the past few days.
In addition to increasing allotment amounts and enhancing the provision of longer-term
unlimited
refinancing, recent actions enable the Eurosystem to provide euro and dollar
liquidity through fixed-rate tenders. Furthermore, the expansion of the list of assets eligible as
collateral considerably enhances the access of counterparties to Eurosystem liquidity. These
exceptional measures aim to restore confidence and the smooth functioning of money
markets. Central banks are closely monitoring this situation and remain ready to act. They
have clearly demonstrated their will to take action when necessary.
But governments are also intervening to bolster banks' solvency and soundness. In this
context and in order to ensure that national measures for dealing with the crisis are
consistent, the international community is taking a collective stand. The G7 plan of action is a
major step forward. It sets out clear principles to be applied by the whole international
community - in particular the IMF's International Monetary and Financial Committee - with a
view to giving structure to national actions.
It expounds the following principles:
•
taking decisive action to prevent the failure of financial institutions;
•
taking all necessary steps to unfreeze credit and money markets;
•
ensuring that banks and other major financial intermediaries can raise capital as
needed;
•
ensuring that national deposit insurance and guarantee programmes are robust;
•
ensuring accurate valuation and transparent disclosure of assets, as well as
consistent implementation of high quality accounting standards.
Thanks, in particular, to France's leading role in discussions, Europe is organising itself. The
meeting of the Heads of State and Government of the euro area, held at the Elysée Palace
on 12 October, with the participation of the President of the ECB, provides Europe with a
structured and coherent framework:
•
possibility of recapitalising banks;
•
guaranteeing new medium-term bank debt (1-5 years), via, in France, a EUR 320
billion funding vehicle;
•
revisiting the accounting rules, with the recent reforms of the IASB - international
accounting standard-setters - and introducing greater flexibility in mark-to-market
accounting rules, allowing assets for which there is no longer a market to be valued
at amortised historical cost.
Moreover, the European Investment Bank will be mobilised to support European SMEs.
Lastly, long-term discussions will commence on the best way to regulate finance and how it
may better serve economic development.
3. The position of French banks and credit
Our banks are not immune to the crisis. They have direct exposures, in particular through US
monoline insurers. They have had to make sometimes substantial write-downs. They are
also impacted indirectly by the seizing up of certain markets and the rise in their refinancing
costs.
That said, our banks are sound and
profitable. It is worth recalling four facts that, in the
current period of turmoil, are often overlooked:
•
The solvency ratios of French banks are high, and much higher than the minima
imposed by the prudential regulation.
•
Our banks, overall, remain profitable: over EUR 7 billion in the first half of the year.
We ensure, contrary to certain rumours, that these earnings are reported using the
strictest standards. In all probability, this trend - of lower but positive profits - should
continue for the rest of this year.
•
One reason for this profitability is that our banks have regular sources of income.
They are universal banks. This sets them apart from banks in some other countries
that depend exclusively, or for the most part, on financial markets. Our banks have a
sound and recurrent source of future profits. This is a vital asset in periods when it is
impossible to raise capital by issuing shares on the market.
•
Lastly, the "manoeuvrability" of our banks remains excellent, as the recent takeover
of Fortis' assets by BNP Paribas shows.
•
It should be recalled that almost all money-market mutual funds (SICAV de
trésorerie) are offered by major banks. Everything that the President of the Republic
has said and everything that I have just said about the soundness of our banks also
applies to these funds.
Credit developments
are the subject of much focus in the current period. A cautious and
balanced approach is required in their analysis and excessive optimism or pessimism should
be avoided. The main facts can be resumed as follows:
•
As a snapshot, credit growth remains strong (over 10% per year for companies and
9% for households). But this partly reflects the weight of past decisions and specific
factors relating to the reintermediation, by banks, of previously securitised loans.
•
All surveys point to a tightening of credit standards going forward. "Tightening" does
not mean that credit will dry up, but rather that it will be more expensive and more
selective. Banks are gradually passing on to their customers the increase in the cost
of financing that they incur.
• We are closely monitoring this development that, at present, does not appear to be,
in itself, a threat to growth. Indeed, the recent period had been characterised by an
extremely high credit growth rate. As you know, the government has implemented
measures to facilitate the financing of SMEs.
To conclude, in the longer term, and in accordance with the guidelines laid down by
revisit
European governments on 4 and 12 October 2008, I believe that it would be useful to
the foundations of our financial regulation. This should be done without haste, but no stone
should be left unturned.
We must be willing to address all the questions and challenges that this crisis has raised.
These include the role of credit ratings agencies, the management of risk, market
infrastructures, the scope of financial regulation and the question of remuneration. As
regards the latter, we should not seek to over-regulate or punish, but rather to instil a sense
of responsibility. Pay structures should not encourage short-termism or, as was the case,
excessive risk taking.