peter praet : deleveraging and the role of central banks speech by mr peter praet, member of the executive board of the european central bank, at the conference “ the effect of tighter regulatory requirements on bank profitability and risk - taking incentives ”, bocconi university, milan, 26 october 2012. * * * i would like to thank roberto motto, federic holm - hadulla, cornelia holthausen and angela maddaloni for their contributions to the preparation of this speech. ladies and gentlemen, i am pleased to speak today at this renowned banking conference at bocconi university. the banking sector ’ s deleveraging process in the euro area has been underway since 2008. until recently, most of the adjustment was achieved by increasing capital via equity issuance, conversion of hybrids, capital injections and retained earnings. with the intensification of the sovereign debt crisis there has been stronger pressure to also adjust via asset shedding, especially those assets with higher risk weights. the deleveraging process, while necessary, always bears the risk of becoming abrupt and disorderly, thus threatening the provision of credit to the non - financial sector and the transmission mechanism of monetary policy. in my remarks today i will highlight the challenges for the central bank in dealing with this process, arguing that the measures undertaken by the eurosystem in recent years have helped to prevent self - enforcing spirals and a credit crunch. i will then focus on the special circumstances of the euro area, given its institutional features. finally i will highlight the expected benefits associated with moving towards a strong banking and financial union in the euro area. banking sector ’ s deleveraging from a policy perspective it is useful to think about banks ’ deleveraging as arising from two possible sources : demand factors and supply factors. although somewhat artificial, this distinction may be instructive in guiding the appropriate policy response. typical demand factors are the lack of profitable opportunities for investment or the presence of deleveraging forces arising in other sectors of the economy. supply factors are related to banks ’ insufficient balance sheet capacity to hold assets. this can arise from capital shortfalls or funding strains – or both. banks can address capital shortfalls and funding strains by adjusting the asset and / or liability side of the balance sheet. asset shedding is the most far - reaching solution. if balance sheet pressures arise from funding strains, banks may decide to sell the most liquid assets and non - core assets that can be liquidated in a

birth rates in the future would most likely come too late to solve the problems faced by many pension systems in the coming decades. pension systems in europe rely heavily on state - run pay - as - you - go arrangements. funded pension arrangements, be they publicly or privately managed, are generally less developed. pay - as - you - go systems are particularly vulnerable to demographic change : with a declining ratio of the labour force relative to the number of pensioners, the tax base shrinks while the number of recipients increases, leaving policy - makers to adjust the system through reductions in benefits and increases in contributions. it should be noted that debt financing of the gap between pension contributions and pension payments does not represent a viable alternative. given the public knowledge of the pension system dynamics, participants in financial markets would anticipate the unsustainability of delaying pension system reform and require higher risk premia on new debt. in this respect, it is helpful that governments of the euro area have committed themselves to refrain from excessive public deficits through the maastricht treaty and the stability and growth pact. in order to deal with demographic changes, european governments are moving in several directions. so - called parametric reforms strive to put the existing pay - as - you - go systems onto a sound financial footing. they include changes to contributions and benefits, such as adjustments in the indexation of existing pensions and in benefit formulas for new pensioners. two approaches are particularly noteworthy, and the swedish pension reform has been impressive in this respect the first is the introduction of longevity adjustments in the benefit formula, which can insure the system against unforeseen – but welcome – increases in life expectancy after retirement. the second is the introduction of a notional defined contribution system which closely links an individual's contributions to his or her own future benefits. however, parametric reforms have limits : raising contribution rates would increase distortional taxation of labour with a negative impact on labour markets. indeed, labour market reforms are also needed to counter the detrimental effects of the ageing of the population. one should, for instance, consider measures aimed at stimulating the supply of labour. moreover, limiting benefits runs the risk of increasing poverty among the elderly. an alternative and complementary route to securing future pensions consists in systemic reforms, namely a move toward more funded systems. this would partially replace labour taxation with an accumulated capital stock as the source of financing for pensions. several countries, such as denmark and the netherlands, use private savings for future