Jean-Claude Trichet: The ECB's response to the crisis
Statement by Mr Jean-Claude Trichet, President of the European Central Bank, at the
European American Press Club, Paris, 20 February 2009.
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Ladies and gentlemen,
Please allow me first of all to thank the European American Press Club for organising this
event and giving me the opportunity to share with you some thoughts on the financial
turbulence. I will describe, in this context, the steps taken by the European Central Bank.
I had the pleasure of addressing you in January 2005, when I talked about the euro's
successes and challenges. Four new countries have since joined the euro area, with the
result that 329 million citizens now share the same currency.
The financial turbulence intensified significantly in September of last year and has quickly
spread from the financial sector to the real economy. In sharing my thoughts on this subject, I
will talk about the role of the operational framework of the Eurosystem, which comprises the
European Central Bank and the national central banks of the euro area. I will describe the
measures implemented by the European Central Bank in response to this difficult and
unprecedented situation, and I will stress the role played by cooperation between central
banks at the international level.
The current turbulence poses a serious challenge to the financial system as a whole and to
economic policy-makers and regulatory authorities around the world. Since August 2007
central bankers have sought to address the increased volatility and risk in financial markets.
This environment deteriorated considerably in September and October of last year, when
several market sectors effectively closed and a systemically important financial institution
went bankrupt.
The primary objective of the European Central Bank is to maintain price stability (defined as
price increases below, but close to, 2%) over the medium term. Achieving this objective
involves more than just establishing our monetary policy stance and setting key interest
rates. Under our operational framework, we also implement our monetary policy by
conducting open market operations with a view to steering short-term interest rates in the
interbank money market.
Since the financial market turbulence began in August 2007, the Eurosystem's open market
operations have, in addition to steering short-term interest rates, also sought to ensure that
solvent banks have continued access to liquidity. Our endeavours in this area have focused
on helping to alleviate the tensions hampering the functioning of the money market.
The Eurosystem's "intermediation role" has grown significantly over the last five months. We
are now providing - and this is quite exceptional - unlimited refinancing to the banks of the
euro area for maturities ranging from one week to six months in exchange for eligible
collateral. This measure was necessary in order to counter the increased tensions observed
for the shortest maturities in the money market, where a sharp steepening of the yield curve
had been observed for unsecured loans. For instance, the spread between the unsecured
three-month EURIBOR and the rate on overnight index swaps, which is normally extremely
small at around 4-5 basis points, reached a historic 186 basis points in October 2008.
I would now like to describe in detail the means by which the ECB's monetary policy has
been implemented during the period of financial market turbulence, as such aspects are of
considerable importance in the context of the current crisis.
The role of the Eurosystem's operational framework during the period of financial
market turbulence
There is no doubt at all that the current turbulence represents the biggest challenge that the
Eurosystem's operational framework has had to face since it was established more than ten
years ago. Recent experience has shown that certain structural characteristics of our
framework have played a decisive role in the stabilisation of short-term money market rates,
thereby contributing to financial stability.
•
First, the fact that a large number of counterparties - hundreds of banks throughout
the euro area - are eligible for the Eurosystem's refinancing operations and
marginal lending facility allows liquidity to be provided to the wide range of banks
that need it where the money market fails to function correctly.
•
Second, the very large volume of our refinancing operations has allowed the
Eurosystem to provide refinancing to eligible counterparties which no longer have
normal access to the interbank money market. At the same time, the Eurosystem
has continued to steer liquidity in an appropriate manner in the course of reserve
maintenance periods.
•
Third, the fact that, since the creation of the euro, a wide variety of assets have
been accepted as eligible collateral in refinancing operations has allowed banks to
obtain refinancing against those assets through the Eurosystem.
•
Fourth, the Eurosystem's operational framework has, since the creation of the euro,
allowed financing to be provided to banks for several months (three months), which
is not generally the case for other central banks.
The European Central Bank's response to the financial crisis
I will now look in greater detail at the various ways in which the European Central Bank has
responded to the financial crisis, the rationale underlying those actions and the effects of
those measures. I will focus on the means by which the ECB's monetary policy has been
implemented, which are of vital importance in the light of the current crisis.
The first phase of the turbulence
During the first phase of the financial market turbulence, which ran from August 2007 to
midSeptember 2008 and was characterised by a systemic shortage of liquidity, the ECB
modified the technical procedures used for the supply of liquidity in normal times, using all of
the room for manoeuvre provided by its operational framework for the implementation of
monetary policy.
• distribution of liquidity
First, the Eurosystem adjusted the over the reserve
maintenance period, providing liquidity earlier than in normal times. Thus, at the
beginning of the reserve maintenance period we systematically allotted liquidity in
excess of the theoretical benchmark amount in our main refinancing operations,
while still aiming for balanced liquidity conditions at the end of the maintenance
period. The total amount of liquidity provided in the course of the maintenance
period thereby remained unchanged. These measures sought to take account of the
changing profile of banks' demand for liquidity.
• Second, the Eurosystem also provided the banking system with liquidity through
open market procedures, which had rarely been used - if at all - prior to the
turbulence. Particularly in response to banks' increased demand for longer-term
financing, the Eurosystem extended very significantly the average maturity of its
lending to euro area banks. Consequently, with a view to leaving the total amount of
outstanding refinancing unchanged, the amount of liquidity provided through
oneweek main refinancing operations was reduced accordingly.
• It is also important to note that international cooperation between central banks was
strengthened at a very early stage through increased exchanges of information and
the collective monitoring of market developments, and then, in mid-December 2007,
through concerted measures in the implementation of monetary policy (which for the
ECB meant providing euro area banks with liquidity in US dollars). In the past,
cooperation between central banks had traditionally concerned the area of
exchange rate policy.
These measures allowed the Eurosystem to manage the tensions observed in short-term
interest rates, as well as having a positive effect on conditions in longer-term markets.
The second phase of the turbulence
However, in mid-September 2008 concerns regarding credit risk increased significantly,
tensions immediately spread from the United States to the euro area and the money market
more or less stopped functioning. At that point, the Eurosystem intensified its actions with a
view to allowing solvent banks to carry out their activities. As a result, a number of
unprecedented additional steps were taken.
•
Thus, in mid-October the ECB took the quite exceptional step of adopting a fixed
rate tender procedure with full allotment
for all of its weekly main refinancing
operations and its longer-term refinancing operations with maturities of up to six
months. This will remain in place for as long as is necessary given the situation in
the markets.
•
It also increased the number and frequency of longer-term refinancing operations,
conducting three additional refinancing operations per month - two with a maturity of
three months and one with a maturity of six months - and introducing a special-term
refinancing operation with a maturity corresponding to the duration of the reserve
maintenance period.
•
In parallel, the ECB implemented a new series of exceptional measures seeking to
temporarily extend the list of assets
eligible for use as collateral in Eurosystem credit
operations.
• US dollar financing
Finally, the ECB increased the provided to its counterparties by
conducting fixed rate tender procedures with full allotment and maturities ranging
from one week to three months through swap agreements concluded with the US
Federal Reserve System.
These measures, which reflect the very significant strengthening of the Eurosystem's
intermediation role during this period of turbulence, have allowed solvent banks continued
access to liquidity despite the dysfunctional nature of the money market. They have also
helped to alleviate the tensions observed in certain sectors of the money market. For
example, the spread between unsecured longer-term EURIBOR rates and the rates on
overnight index swaps has declined considerably - although it remains elevated, significantly
higher than the levels observed prior to September 2008.
In practice, these measures allow euro area banks to obtain as much euro liquidity as they
wish, whether through our weekly operations or our longer-term refinancing operations, using
a wide range of assets as collateral. In total, the Eurosystem's balance sheet rose by about
EUR 600 billion since end-June 2007 and today, an increase of about 65%; with the assets
reflecting the strong increase in the volume of liquidity provided and the liabilities reflecting
banks' concomitant recourse to the deposit facility. These measures have proved effective in
overcoming the liquidity shortage in the interbank market. However, they cannot eliminate
the increased concerns regarding credit risk. In this regard, the conditions in the money
market have not yet normalised and remain strongly affected by an elevated degree of risk
aversion.
The increase in the Eurosystem's intermediation role has proved necessary in response to
the current dysfunctional nature of the money market, but this cannot - and must not - be
regarded as anything other than a temporary measure. The Eurosystem wishes, of course, to
see a return to interbank lending and traditional intermediation activity by banks. The ECB's
recent decision to return to 200 basis points the corridor formed by the interest rates on the
standing facilities either side of the rate on the main refinancing operations aims to stimulate
interbank activity. In this respect, we are observing a reduction in banks' demand for
refinancing in our open market operations and a correlated decline in recourse to the deposit
facility. In parallel, we are witnessing an increase in the volumes underlying the calculation of
the EONIA.
Cooperation between central banks
Faced with the development of the financial market turbulence, central banks have already
taken numerous steps to counter systemic liquidity risk, demonstrating their determination in
this regard on numerous occasions.
Since December 2007, the ECB, thanks to a swap agreement with the US Federal Reserve
System, has been providing euro area banks with liquidity in US dollars in exchange for
eligible collateral.
This exceptional measure seeks to alleviate the tensions observed in short-term funding
markets. Since the launch of these operations, the range of maturities covered has grown
and the amounts allotted have increased, with financing being allotted by an increasing
number of central banks. As regards the Eurosystem, the framework for this facility was
extended in October of last year when the ECB decided, in agreement with other central
banks, to offer financing in US dollars at various maturities by means of fixed rate tender
procedures with full allotment. Since October 2008 the ECB has also provided euro area
banks with liquidity in Swiss francs through a swap agreement concluded with the Swiss
National Bank.
The financial turbulence has shown that, by stimulating confidence, particularly in periods of
considerable uncertainty, cooperation between central banks in various areas can prove an
effective response to both national and global challenges.
Conclusion
Ladies and gentlemen, I would like in conclusion to say a few words about a most important
question, I mean confidence. The intensification of the financial crisis, which occurred last
September, was triggered by an abrupt loss of confidence striking simultaneously the
financial system as well as the real economy, the industrialised countries as well as the
emerging economies.
Improving confidence is one of the necessary conditions to overcome the present woes. The
European Central Bank and its Governing Council do everything which is possible to
preserve, enhance, strengthen confidence. More than ever our institution has to be an
anchor of stability, therefore an anchor of confidence, in these uncharted and turbulent
waters. The euro area and our 329 million fellow citizens can count on the ECB and the
Eurosystem to take the necessary decisions whilst having always in mind monetary and
financial stability as an aim in the medium and long term.
Thank you for your attention.