george a provopoulos : from financial crisis to financial stability – a european odyssey speech by mr george a provopoulos, governor of the bank of greece, at the bank of poland biannual eu presidency lecture “ from financial crisis to financial stability : a european odyssey ”, warsaw, 12 february 2014. * * * i would like to thank president belka for inviting me to be here. the occasion of these lectures provides an opportunity to take stock of the progress made toward european monetary and economic integration and the work that lies ahead. my discussion of these issues will be structured as follows. i will begin by describing some important shortcomings in the original euro area institutional set - up. this will lead me to a discussion of the origins of the euro area crisis. next, i will describe the ecb ’ s reaction to the crisis, as well as the measures that have been, or are being taken, to address the euroarea ’ s shortcomings, focusing on economic governance and banking union. i will then take stock of where we stand today – both in the euro area as a whole and in peripheral countries. finally, i will comment on what remains to be done to make europe more dynamic and globally competitive. the euro area at its formation and the origins of the crisis when deciding on what architecture to give to the monetary union, policymakers settled on a “ bare - bones ” approach. the approach rested on an independent, price - stability - oriented central bank – the ecb – and fiscal discipline by the individual countries, fostered by the rules of the stability and growth pact and enforced by the markets. the maastricht treaty called on countries to pursue sound economic policies that would support the ecb in maintaining its price - stability goal. the dominant view at the founding of the emu was that current - account imbalances among countries in the monetary union would become as irrelevant as they are among regions of individual countries. persistent current - account deficits were interpreted as capital flows from countries offering relatively - low returns on investments to countries offering relatively - high returns. in other words, they were welcomed as part of an equilibrating process under which the fast - growing periphery caught up to the core. this architecture proved inadequate for several reasons, setting the stage for the euro - area crisis. first, the fiscal rules were poorly designed and under - enforced. as a consequence, in the years leading up to the crisis, the ratio of sovereign debt to

this is to say, the instruments based on capital and liquidity overlays mainly reduce risk in the system by increasing the resilience of bank balance sheets rather than by having a significant dampening effect on asset cycles. lvr restrictions, on the other hand, have the potential to reduce risk more directly : both by reducing the riskiness of loan portfolios ; and also by dampening asset prices through a reduced supply of credit. bis central bankers ’ speeches international precedents for use of the first three instruments are limited. the ccb is part of the new basel iii regime which is live from january 2014 for new zealand and somewhat later for many other countries. the deployment of a scr has been recently announced by the swiss and will come into effect in september. they are applying a capital overlay of 1 percent against all residential mortgages. the cfr is an existing micro - prudential tool, similar to the net stable funding ratio ( nsfr ) under the basel iii regime. as a macroprudential tool, the cfr is unique to new zealand, although the possibility of using the nsfr as a macro - prudential tool has been under consideration in the united kingdom. there are considerably more precedents for the use of lvr restrictions and i will elaborate on these shortly the point i want to make here is that, of the four macro - prudential instruments, the lvr instrument is the one with the best scope to dampen the current strong demand for housing, as well as reducing the riskiness of bank balance sheets. for this reason the reserve bank is looking closely at the use of lvr restrictions to address the growing housing market threat to financial stability. while all four of the macro - prudential instruments remain valid options, i will use the rest of my time to focus on lvr restrictions and how they would work. loan - to - value restrictions as i mentioned, lvr restrictions have the most potential to reduce risk both by making bank balance sheets less risky and by dampening housing market pressures through reduced credit supply. borrowers with high lvr loans are often stretching their financial resources, paying a deposit of less than 20 percent and often also having high debt service ratios ( dsrs ). such borrowers are more vulnerable to an economic or financial shock such as a recession or an increase in interest rates. a high lvr loan is more likely to be underwater in the event of a default and is therefore a riskier proposition