samchain/econo-pairs-v1 huggingface dataset:
Már Guðmundsson: Preserving the credit of the sovereign through a financial sector meltdown – the case of Iceland Speech by Mr Már Guðmundsson, Governor of the Central Bank of Iceland, at the International Monetary Seminar 2013 “Sovereign risk, bank risk and central banking”, organised by the Bank of France, Paris, 8 July 2013. *  *  *  I would like to thank Banque de France for inviting me to speak at this interesting seminar. This session is on resolving sovereign debt crises and the relative roles of the public and private sectors in that process. My comments will obviously be based on my own country’s experience during the financial crisis, which is a case of a sovereign debt crisis being avoided in spite of the meltdown of a large part of the financial sector and the country’s deepest recession since the interwar period. That result was achieved by relatively good fiscal position prior to the crisis, by a refusal – based on need rather than stubbornness – to rescue private cross-border banks with public money, and by on-going medium-term fiscal consolidation that was an important part of the economic programme developed in cooperation with the IMF. The bottom line is that all sovereign obligations have been honoured; the sovereign has maintained investment-grade credit ratings and market access.

Inflation Expectations of the Players in the Money Market Agents)  In flation Expectation s of th e Players in th e Mon ey Market Agen ts Per cen t 5  5  J an .’95 4  4 3  F eb .’ .’9 96  CP I  No v .’ .’9 97  2  2  F eb .’ .’9 98  1  3  1  F eb .’ .’9 97  0  0  -1  -1 94  95  96  97  98  99  00  01  02  So u r ce cess : St at i s t i cs S wed en an d Pr o s p er a R es ea r ch  BIS Review 14/1998  -9-  Question 7: Is the policy asymmetrical? It takes time before a change in the instrumental rate affects the economy and inflation. Therefore monetary policy always has to be formulated with the aid of forecasts of future inflation. When the Riksbank formulates monetary policy it is done with the aid of a forecast one or two years into the future. A simple rule of thumb should be able to describe monetary policy: if our overall assessment of inflation – assuming that the instrumental rate remains unchanged – indicates that inflation will deviate from the objective for two consecutive years, the instrumental rate must be changed in the corresponding direction.
Independence is therefore a further condition for ensuring that a central bank retains its freedom of action at all times. Independence is more than an abstract construct. It gives the central bank the freedom to act swiftly, resolutely and credibly, if needed. What independence also means, however, is the responsibility to use this freedom strictly within the meaning of the statutory mandate, no matter what the prevailing political climate may be. Independence cannot be taken for granted, it is a privilege. It was granted to us under the Constitution in order that we could achieve the goal of price stability in the long term. As a counterweight to its independence, the SNB has a duty of accountability and information with respect to parliament and the public. The SNB is thus  4  BIS central bankers’ speeches  firmly anchored in our constitutional democracy. In a free society, an authority with a complete free hand would be a foreign body. Favourable environment created by Confederation and cantons Yet independence must also be lived. The SNB may not accept instructions from political authorities; neither can it allow itself to be put under pressure by public opinion. It must conduct a monetary policy that serves the interests of the country as a whole, to the best of its ability, and in accordance with its mandate. It is only natural that our monetary policy cannot please everyone at all times. However, an independent central bank must not be put off by this.

Yet the concerns which used to be expressed about preventive approaches are not entirely without foundation. It is not usually possible for central banks to fully measure the build-up of excesses on financial and asset markets in real time, to intervene at exactly the right time and thus put a stop to dangerous bubble formations at precisely the right moment. However, the current macroprudential toolkit neither claims nor intends to do this. Just as monetary policy is unsuited to fine-tuning the economy, macroprudential measures are also little suited  6  BIS central bankers’ speeches  to fine-tuning asset and credit markets. Instead, what is involved are relatively limited interventions in order to prevent foreseeable larger imbalances that might possibly endanger financial stability at a later stage. While there is broad international consensus that the new instruments make sense, there is a wide difference of opinion about how the institutions that use them should be organised. In some cases, new bodies have been created to examine the use of these instruments, while in other cases responsibility has been placed fully in the hands of the central bank. A number of countries have gone even further by handing over the traditional area of individual banking supervision to central banks as well. Similarly, it is equally impossible to use a one-size-fitsall approach for all the measures and instruments introduced in different countries.
We should have an optimistic view of the future and at the same time make sure our stance is realistic and consistent. Time is ripe for Albania to start producing more goods and services than before. Despite the admirable progress in this context, the gap is still wide. Agriculture and industry remain two important branches of the economy operating far from their potential. Additionally, other sectors that have revitalized during the transition years require more orientation and tuning. These measures will enable better diversification of the Albanian economy, augmenting its stability with the passing of time. Other challenges I believe relate to the country’s external position, implying the reduction of current account deficit and the provision of alternative resources of foreign currency inflows. Therefore, I think that the role of the state needs to be more pronounced, not only in terms of completing the legal and regulatory basis but also of concluding a number of important structural reforms, in particular those related to the land, ownership titles, pensions, to the support of the small and medium-size business, to the further improvement of business environment and the ongoing upgrade of national infrastructure. The further strengthening of safety nets, in the context of a stable fiscal and financial position, is an obligation whose accomplishment would reduce both the real and perceived risk of the Albanian economy, hence creating incentives for the growth of domestic and foreign investments.

In addition, the Bank of Albania has supplied and continues to supply the interbank market with the required amount of liquidity. BIS Review 148/2008  1  As I have mentioned in my previous statements: There’s no such thing as a free lunch! Meaning that emphasis should be put on the far-sighted perspective characterizing the Bank of Albania in the recent years. I do not refer here only to price stability, but also to the greatest challenge: banking system stability. The Supervisory Council of the Bank of Albania has constantly amended the regulatory basis creating incentives for more qualitative lending, while other decisions have aimed at providing more banking system transparency to the public, more efficient internal control and better management and governing structures. Regardless of what has been stated above, the future is of prime importance. For many reasons that I have also mentioned in my previous statements, end-year 2008 and almost the entire year 2009 will in a global context be hard, full of challenges and we will be walking through unknown paths. Overcoming this economic crisis requires time. Its solution will materialize through the resetting of a number of internal and external economic balances, the re-arrangement of many supervisory institutions and the re-design of the regulatory framework on many financial market segments. Put in this general setting, the idea that our small economy would resist this global economic tsunami with no consequences at all sounds as unrealistic. However, this issue is even more intricate.
Nevertheless, akin to efforts in the United States, European banking supervision decided to look closely at these exposures – taking a forward-looking and pre-emptive approach. The growth of the market indeed seems to be driven by a search for yield. And on the face of it, leveraged finance does provide comparatively high yields. In 2014, leveraged-finance products generated more than € billion of net revenues for European banks. In particular, leveraged finance offers an opportunity to increase fee incomes. Accordingly, the volume of underwritten transactions has increased by 35% since 2012, whereas the volume of deals that banks hold in their own books has only increased by 16%. It would appear that banks are doing it for the fees. Still, other factors besides a search for yield are driving the market for leveraged finance: corporate refinancing schedules, for instance. In 2014, about 52% of transactions took place in order to renew or refinance previous deals. Also, greater confidence among investors might play a role. Rating agencies, banks and investment funds have communicated profusely on low default rates and the general attractiveness of the market for leveraged finance. However, the border between confidence and overconfidence is hard to define. Therefore, the question is: should we keep an eye on leveraged finance? My answer as a supervisor is: yes, we should.

Leveraged finance is certainly not a major supervisory concern at the moment, but the recent development of the relevant market exemplifies the need for good risk governance, a welldefined and closely monitored framework for risk appetite and highly assertive risk management. Search for yield has intensified competition in the market for leveraged finance. The result is that the terms for borrowers have become more favourable – ultimately, that increases the risks for the lender. We as supervisors take a close look at the credit quality of borrowers as measured by their level of leverage. Lending to highly leveraged counterparts may entail significant risks. And in the euro area, we observe that the leverage of corporate borrowers has increased. In 2014, 35% of transactions arranged by significant institutions actually refinanced borrowers at an increased level of leverage. Moreover, we as supervisors are not always impressed by the quality of loan contracts. Some loans contain only limited obligations for borrowers, for instance with regard to payment terms. Particularly when refinancing or renewing commitments, banks might be inclined to accept the removal of covenants in order to preserve existing commercial relationships. We as supervisors also care about returns. Banks are taking on risks; but do they gain adequate returns? Well, over the entire credit cycle, they may not necessarily earn more returns because there are other factors at play.
But more is needed, especially regarding a more solid institutional framework to repair balance sheets in a way that limits systemic risk and avoids damage to the real economy. The Japanese experience has shown the risks created when banks’ balance sheet problems are not recognised and addressed. Weakly capitalised banks initially extended loans to insolvent firms to limit the recognition of losses in the short run. Indications of evergreening became prominent as the share of loans to the construction sector continued rising for years after the bubble had burst, despite the fact that this sector was adjusting and needed to downsize. Write-offs on non-performing loans and necessary recapitalisations were delayed and the financial sector remained highly vulnerable to shocks. But delayed recognition was also facilitated by valuation standards that did not mark non-performing loans to market, unlike much of the losses from securitised products in the recent crises. In addition, the refusal of banks to foreclose on borrowers might have reflected a different resolution culture and code of civility in Japan; namely, one that eschews the large turnover of jobs and the frequent discharging of workers and avoids inducing a humiliating “loss of face” for delinquent borrowers.8 For the real economy, the evergreening of loans implied a weakening of growth prospects.9 Potentially more efficient enterprises were denied financing, thereby hampering the natural entry and exit of firms to the market place. Indeed, with the recession in Japan at the  7  See ECB, Financial Stability Review, May 2013.

We may be more familiar with “less is more”, which is the mantra for designing friendly user interfaces or cool technology products. But new platforms in retail payments, data infrastructure and cross-border payments tend to be more successful and sustainable when they achieve widespread adoption and leading to strong network effects. 23. Just think about FPS. Would you still use it every day if your friends and family were not on the platform? From the design stage, we aimed to include more currencies and payment institutions, so as to attract a rapid build-up of users. The result is the world’s first multi-currency instant payment system connecting banks, e-wallets, and customers. With this strong network effect, FPS adoption in Hong Kong is perhaps one of the fastest in the world. We are strengthening this network effect further by introducing FPS payments for merchants and government bills. 24. Or think about why we launched CDI. Data is an essential nutrient to technological development. Currently, commercial data is scattered across isolated data islands built bilaterally between banks and individual data providers. The idea of CDI is to provide a common data infrastructure that will replace these compartmentalised, one-to-one connections with an efficient many-to-many connection. Banks will have common access to a sea of data which allows them to compete on innovation in service delivery. For this to happen, we need scale. We need to connect as many data providers, data consumers and data owners as possible in order to create the network effect. 25.
Where no market price is available or those that are available are judged to be unreliable – for example because they are out of date – the Bank calculates a model price to value a security, based on a standard bond pricing model of discounted expected future cash flows. The Bank uses its judgment to assess the validity of that model price, including by comparing it to similar traded securities where available, and drawing on any relevant market intelligence it has gathered from market participants. Haircuts The Bank’s haircuts are designed to reduce the likelihood that the Bank would incur a loss if forced to realise and liquidate collateral in the wake of a counterparty default. So the haircuts not only have to protect against the risk of counterparty default (credit risk), but also take account of the likely value of that collateral in stressed liquidity conditions (market risk). As a result, the Bank adopts a graded approach, with “base” haircuts varying by the type of collateral offered reflecting the different associated risk characteristics. It includes the likely correlation of risk e.g. that the value of a counterparty’s collateral will fall as the counterparty itself becomes stressed. Over and above those base haircuts, and where appropriate, the Bank imposes idiosyncratic haircut add-ons, based on both the type of collateral and the counterparty. In some cases, that reflects stress tests applied to the underlying assets.

That means that less conservative haircuts would sometimes be required to support a given level of borrowing. That will benefit counterparties as well as deliver risk management benefits to the Bank. The Bank will also require the data to be made available to investors and other market professionals, so that they will be able to undertake their own risk analysis. That should deliver longer-term benefit to the financial system as a whole – standardising, simplifying and publicising the data should all reduce the mechanical reliance on third party judgments and  8  The counterparty can meet the margin call by either providing more collateral, substituting some of the existing collateral with higher quality assets which receive a smaller haircut, or returning some of the lent funds. 9  The aim would be for the Bank’s risk tolerance to be broadly the same for loans as for a securitisation of those same loans, so as not to provide incentives to submit one form of collateral over the other. BIS central bankers’ speeches  7  models, and hence reduce “single points of failure” within the ABS market (although it will be up to market participants to make best use of these changes). Other policy issues on the agenda There are some big issues facing the Bank and its collateral management going forward. The immediate challenge is to wind down the SLS to its conclusion in January 2012.
The development of cheap and innovative digital payment solutions is leading to a decline of the use of cash in transactions, and an increase of cashless payments, which leads to a wider use of commercial bank money. Besides, our European ecosystem has become critically dependent on non-European players – already major global card-schemes, and more and more Bigtechs – with little control over business continuity and data protection. Meanwhile, the development of crypto-assets and socalled “stablecoins” aims to create a new category of settlement assets. Stablecoins may compete against both commercial and central bank money, even though they do not offer the same guarantees in terms of credit risk, liquidity, service continuity, and neutrality. Indeed, current digitalisation triggers at least two important risks: (i) the risk that BigTechs will build private financial infrastructures and “monetary” systems, competing with the public monetary sovereignty; and (ii) the symmetric risk that some jurisdictions judge that the only way to respond to the overwhelming private payments’ wave would be to issue and spread on a domestic but also a global basis, “their” CBDCs (Central Bank Digital Currency). 2/4  BIS central bankers' speeches  I already called – including here at Europlace – for a holistic European payments strategy. The good news is that in the last months we made decisive progress in designing it, thanks to the commitment of the Commission and the ECB. Christine Lagarde as President, and Fabio Panetta as Board’s member in charge of payments changed the game through their personal involvement.

Bond yields reversed their movements from the early part of the pandemic, with 10 year US treasury yields rising by 65 bps in this period and 10 year gilt yields moving 64 bps higher. Bid-offer spreads on US treasuries widened by a factor of 10. The gold price fell by 12%. Investors suddenly looked to redeem from money market funds (MMFs). Sterling MMFs saw outflows of 11% in just over a week. Similar outflows were seen in the US prime MMFs. This self-reinforcing dynamic was broken by massive central bank intervention. On 19 March, the Monetary Policy Committee (MPC) announced the stock of asset purchases would increase by £ of gilts. We also launched special repo operations (the Contingent Term Repo Facility), a 1/6  BIS central bankers' speeches  credit scheme (the Covid Corporate Financing Facility), extended term credit to banks (the Term Funding Scheme with additional incentives for SMEs) and joined other major central banks in activating the swaplines. In the US, amongst other actions, the Federal Reserve announced a $ asset purchase program, quintupled its repo operations (from $ to $ and established a temporary repo facility for international authorities with a view to support treasury market functioning. In Europe, the Pandemic Emergency Purchase Programme was put in place to purchases eligible assets up to € As a result, order returned to financial markets and subsequently the growing realisation that governments would step in to limit economic damage further restored confidence. What lesson should we learn from that episode?
That left two possibilities: joining the eurozone after a negotiated agreement and continuing with a flexible exchange rate and an inflation target. The problem was that there were drawbacks to both. The financial crisis had uncovered flaws in the design of the eurozone, and it also came to light that political support for eurozone membership was lacking. Independent monetary policy and a flexible exchange rate had not been very successful. Has something changed? The euro area is still putting in place the reforms deemed necessary for it to function smoothly, and it does not seem to me that political support for membership has increased significantly since the Bank’s report was issued. But various reforms have been made to monetary policy conduct in Iceland, and financial stability policy has been vastly improved. Much of what I have called inflation targeting plus has already been put in place. And in the past few years, we have seen that independent monetary policy can work effectively, also in Iceland. This is where we are now. That need not mean that we will be here for the indefinite future. There is no eternal monetary solution, and various options develop over time. 4  See reference in Footnote 3. 10

First, looking back over the past three years, the big picture is that inflation has stayed surprisingly low, and output growth remarkably stable, given the scale of these cost increases. Inflation has never deviated by more than 1 percentage point from the 2 per cent target. But second, judging by the media and public reaction to the rise in inflation over the past few months, it is clear that even a small deviation in inflation from target can now look very significant after the stability of the past decade. This illustrates both the helpful and unhelpful legacy of a decade of remarkable stability for the UK economy. On the helpful side, there is no doubt that a highly credible monetary policy framework has helped to contain inflation, in the face of a very large cost shock. The UK has become a low inflation economy since the 1970s and people expect the MPC to keep it that way. That affects the way they behave when they take decisions about wages and prices. The less helpful legacy is that even a small movement in inflation away from target – one percentage point – has prompted some highly coloured media coverage, and may have unsettled people’s expectations about where inflation is headed in the short run. How does this less helpful legacy affect the policy debate?