Luis de Guindos: Challenges for bank profitability Speech by Mr Luis de Guindos, Vice-President of the European Central Bank, at the OMFIF City Lecture, London, 1 May 2019. * * *  Introduction Sustained economic expansion over the past six years and greater banking sector resilience have supported financial stability within the euro area. But the recent softening of growth prospects heightens risks. The financial stability environment has become more challenging than it was a year ago. The risks that have been with us for some time now – a possible disorderly increase in risk premia, debt sustainability concerns, low bank profitability and imbalances in the non-bank financial sector – are still present. But they are no longer being mitigated by an improving macroeconomic outlook. Indeed, the deteriorating macro outlook renders some of these risks more acute. In particular, it may reawaken concerns over debt sustainability and worsen the outlook for bank profitability. Debt sustainability concerns could drive up sovereign bond spreads. In turn higher spreads generate losses on bond portfolios and higher market-based funding costs for financial institutions. Bank profitability tends to go hand-in-hand with economic activity. Slower growth prospects may dent bank profitability through a reduction in lending activity and a possible increase in credit impairments. Moreover, the ongoing political uncertainties – including trade disputes – and the softer economic momentum may trigger volatility in asset prices. And if a sudden, disorderly increase in risk premia were to materialise, it could further elevate banks’ funding costs.

Let me follow this account of the general framework of regulation governing financial investments denominated in foreign exchange with a description of the structure, strengths and weaknesses of our economy. The basic economic features of our country are attractive. A liberal trade and exchange rate regime, a modern and competitive private sector, abundant and vigorous consumer demand, and extremely attractive investment opportunities. This rosy picture is clouded by three economic problems that can be solved by a firm commitment to macroeconomic discipline. These three problems--high and persistent inflation, high public sector deficits, and large current account imbalances--are interrelated. Persistent high inflation has been Turkey’s main economic problem for the last two decades. Its main cause lies in the sizeable public deficit. Its other causes include entrenched inflationary expectations, exchange rate movements, monetary developments, interest rates, and price increases initiated by public enterprises. Under conditions of an open capital account, large public deficits can generate imbalances in the current account. Turkey’s current account tends to be volatile. For this reason, what Turkey really needs is to accept fiscal discipline. A sustainable and consistent fiscal policy is evidently the key to solving other economic problems. Achieving fiscal discipline will require political will as well as persistence. BIS Review 42/1997  -3-  Even though we have economic problems, we unquestionably also have the ability to overcome them. Turkey needs to make use of this potential. I therefore now wish to draw your attention to the considerable strengths of our economy.