miguel fernandez ordonez : procyclicality in the banking activity speech by mr miguel fernandez ordonez, governor of the bank of spain, at the conference on procyclicality and the role of financial regulation, organised by the bank of spain and the financial stability institute, madrid, 4 may 2009. * * * good morning ladies and gentlemen. first of all i would like to welcome you to the bank of spain. also, let me thank you all for your presence here today to discuss on one of the most difficult and relevant topics affecting financial regulation : procyclicality in banking activity. let me also thank the bis financial stability institute, and in particular its chairman, mr. josef tosovsky, for all the support and good advice received during these last few weeks during the preparation of this event that we have co - organized. we are very pleased to have as speakers in this conference a large group of excellent professionals who are directly involved in financial supervision and regulation. a high level meeting like this one is a major opportunity to start building up a common and efficient framework in order to face the procyclicality issue. cyclicality can be considered an inherent part of economic activity. banking activity is no exception ; it is also affected by the upswings and downturns of the real sector cycles. not only history proves this, but current events do also. any doubt about this has been violently resolved after the summer of 2007. but even if we accept that little can be done to avoid economic cycles, this should not be an excuse for us, central bankers and supervisors. our responsibility is to develop macro - prudential approaches and the appropriate regulatory measures to help banks reduce the impact of future economic cycles and diminish their procyclical behaviour. this should be achieved for the sake of financial stability with the minimum economic and social costs, which is the main objective of supervisory authorities in fact, banking behaviour can be not only cyclical but procyclical, that is, it can exacerbate the cyclical behaviour of the real economy. as it has been said many times, there is nothing more procyclical than a badly managed bank. in good times it incurs in more risks than it reasonably should through, for example, excessive lending with poor standards. in bad times it changes its lending policies reducing drastically the loans to the economy and exacerbating the downturn. there are several causes that explain this

( ii ) the sizeable exposures of the financial sector to this form of risk ; and ( iii ) the presence of externalities. the financial sector is exposed to these physical risks through several channels. physical risks are of course relevant for the valuation of real estate assets, the main collateral of bank loans. physical risks also matter when assessing the ability to pay of borrowers involved in p. bolton, m. kacperczyk, h. hong and x. vives ( forthcoming ), “ resilience of the financial system to natural disasters ”, iese business school and cepr. see the financial stability board ( november 2020 ) : the implications of climate change for financial stability. sectors that could be particularly affected, such as agriculture or tourism. capital destruction could also be very important. furthermore, since not all geographies would be equally affected, the migration of activities and of the population in some areas will increase, generating an impact on the financial sector as well. precisely to prevent these risks increasing further, acting to prevent the materialisation of climate change is essential. however, such interventions, and the accompanying changes in consumer and investor sentiment in favour of a greener economy, may also create their own particular risks to the financial sector. indeed, the transition towards an environmentally sustainable economy implies a sweeping change in production technologies and a reallocation of activity across sectors and companies. actually, such restructuring will mean that, in the short run, some sectors will increase their profits while others will incur losses, with obvious implications for the financial system and its stability. in this case, for estimating transition risks, the most relevant factors are the carbon footprint and the environmental impact of the sectors and companies to which financial firms are exposed. in this context, and as part of our main responsibility to guarantee the stability of the financial system, we - regulatory and supervisory authorities - must ensure that the materialisation of climate risks does not endanger financial stability. therefore, we must make sure that financial firms address these risks. in particular, we should contribute to identifying climate - risk drivers and their transmission channels, to the adequate measurement of the economic and financial impact of the different risks, and to the definition and development of the potential mitigation and riskreduction measures. if we succeed in incorporating these risks into the decisions of the financial sector, this will translate into a change in the relative prices of financial instruments. and, in turn, that will help to internalise those