jose manuel gonzalez - paramo : the challenges of the european financial sector speech by mr jose manuel gonzalez - paramo, member of the executive board of the european central bank, at a conference organized by the spanish national council of the urban land institute ( uli ), barcelona, 26 may 2011. * * * ladies and gentlemen : i. introduction it is a privilege for me to participate in this conference organised by the spanish council of the urban land institute, dedicated to the very important topic of the challenges currently faced by the european banking sector. many of these challenges are associated with the ongoing restructuring process of the banking sector and the completion and implementation of the new european and international regulatory and supervisory framework. the protracted financial crisis that we have experienced since 2007 has unveiled important sources of vulnerability in the financial system. these include weaknesses of the regulatory and supervisory framework of the banking sector, which failed to ensure the safety and soundness of financial institutions both individually and as a system. this has prompted the relevant authorities to pursue a number of reforms of the microprudential supervisory and regulatory framework, while also assigning central banks all over the world macroprudential tasks in recognition of the importance of the systemic component of financial stability. in addition, the crisis has shown that the relationship between financial development and economic growth is not really linear and that, when financial sectors become “ too large ” relative to their home economies, risks to financial stability and macroeconomic stability may arise. moreover, the crisis has undermined the sustainability of some business models that were rather widespread among large international banks, while also exposing the shortcomings of corporate governance and of the evaluation and management of the different sources of risk within financial institutions. given the location of this conference, i should recall that one of the factors that make the current crisis so challenging and costly is the interaction among its various housing - related components ( housing prices, housing finance and the construction sector ). indeed, we know that a housing market bust was typically a feature of the costliest systemic crises experienced over the past century, including the nordic banking crisis of the early 1990s and the japanese financial crisis started in the 1990s. in my intervention, i will try to highlight the aspects of the current policy and regulatory debate that are most relevant for the housing sector. ii. towards a new economic and financial paradigm : the “ new normal ” the crisis has affected the macroeconomic and financial environment in which banks operate. in the aftermath of the crisis, it is very likely

) and fiscal policy ( e. g. tax incentives on mortgage interest rate payments ). the first genuinely macro - prudential tool to have been introduced is the counter - cyclical capital buffer that will be gradually implemented as part of basel iii. this buffer will be activated in periods of excessive credit growth, such as the credit booms frequently originating from or associated with housing price bubbles. further prudential tools include the caps on loan - to - value ratios, loan - to - income ratios or debt servicing - to - income ratios, which are typically applied to mortgage loans. unlike the capital or liquidity requirements, these measure act through the demand for loans, as opposed to their supply by the banking sector. other measures may include additional capital requirements by supervisors for individual banks that are considered by authorities to be particularly exposed to certain types of risks ( e. g. concentration risk in housing markets ). furthermore, intensified supervision, accompanied by specific stress tests may also contribute to more cautious lending policy by banks. in addition, enhanced transparency and more efficient communication of risks to customers ( including increased financial literacy ) may also support a better - informed decision making in housing finance and a more cautious behaviour of clients in this field. the experience of many east european countries over the past decade of widespread borrowing by households in foreign currencies as remote as the yen for the financing of housing purchases clearly points to insufficient financial literacy. before concluding my speech, let me recall that macroprudential policy is not the only instrument available to central banks which is being considered in order to prevent and contain systemic risks. increasing awareness that : ( 1 ) price stability, while being a necessary precondition, is not sufficient for financial stability, and that ( 2 ) in regimes of low and stable inflation with firmly anchored inflation expectations, ample liquidity conditions and unsustainable economic expansions seem to manifest themselves first in the build - up of financial imbalances rather than in immediate inflationary pressures has re - opened the debate about the opportunity of pursing a “ leaning against the wind ” approach to monetary policy. leaning against the wind can be defined as a strategy whereby a central bank would decide, for instance, to set a somewhat tighter monetary policy stance than would be the case under a similar macroeconomic outlook and more normal financial market conditions in the absence of concerns about the emergence of an asset price bubble. this subject deserves a speech on its own, so you will excuse me if i do not elaborate