national bank of serbia opening remarks at the presentation of the inflation report – august 2019 dr zeljko jovic, vice governor belgrade, 14 august 2019 ladies and gentlemen, esteemed members of the press, dear colleagues, welcome to the presentation of the august inflation report, where colleagues from the economic research and statistics department will present to you in detail the current macroeconomic trends and our latest projections. in my introductory address i will touch on the key macroeconomic conditions in which monetary policy was implemented and on the decisions the national bank of serbia has made in the period since our previous report. first of all, i would like to say that favourable macroeconomic trends continued into 2019 – inflation is low and stable, macroeconomic and financial stability has been preserved, and the costs of financing have stayed low, feeding through into higher economic and investment activity. over the past six years inflation has been low and stable, at around 2 %, and is expected to remain so in 2019 and 2020. financial stability has been maintained and the issue of inherited non - performing loans resolved in a sustainable way – their level has been reduced by more than 70 % over the last four years and their share in total loans cut to 5. 2 %. relative to may 2013 when we embarked on the cycle of monetary easing, the interest rates on dinar loans for households are now twice lower and for corporates as many as three times lower. this served as a fillip to investments, which remain one of the key drivers of economic growth this year as well. the sustained positive fiscal trends, with a surplus of 0. 7 % of gdp in the first half of the year, are a reflection of the successfully implemented fiscal consolidation and full coordination of monetary and fiscal policies. all of this has been achieved in the face of unfavourable effects of some factors from the international environment, notably the slowing of global economic growth amid announcements of additional protectionist measures and heightened geopolitical tensions. at the same time, this is a proof that by strengthening our economy, primarily through the reduction of external and internal imbalances and through favourable macroeconomic prospects, we have increased its resilience to unfavourable effects from the international environment. since the may report, external financial conditions have been largely affected by the shift in the monetary policies of leading central banks, which are not only slowing the normalisation process, but also announcing additional monetary stimuli. thus, the federal reserve system lowered its policy rate for the first time since

central bankers ’ speeches but, once again there is a balance to be struck. the recent problems in cyprus give us a hint of this. the cypriot banks were very heavily deposit funded. this turned out to have two distinct disadvantages. the first was that when the value of the banks ’ assets fell, depositors had to bear the brunt of losses after the equity holders. this significantly complicated the resolution of the banks ’ problems. a similar tension is currently evident in some of the international policy discussions. in particular, some regulators want banks to have more deposit funding because it is seen as more stable. at the same time, others want heavily deposit - funded banks to rely less on deposits and issue certain types of wholesale debt to make it easier to resolve a problem should it occur. the second disadvantage is that with only limited wholesale liabilities, the cypriot banks were arguably subject to less market scrutiny than were banks with a different funding structure. one benefit of wholesale funding is that the issuing bank needs to keep turning up to the market and selling its story to sophisticated investors. there is no guarantee that this extra scrutiny will prevent problems, but it is likely to help. the general point from both these examples is that there are tensions in financial regulation. regulations are introduced to address one issue, and another issue emerges. many countries have had the experience of regulating one aspect of the financial system only for other parts to grow very quickly, and problems to emerge in those other parts. i do not want this to be interpreted as a counsel of despair. but we need to be cognisant of the limits of rules alone. it may well be possible that a set of rules could be introduced to ensure that the specific problems of recent times are never allowed to occur again. but what is much less certain is whether these rules could ensure that a different set of problems, but with broadly similar consequences, do not emerge at some point in the future. i suspect that it is simply not possible, or in fact desirable, to regulate a modern financial system to the point that we can say with absolute confidence that problems will not occur. what we can do, however, is to reduce the likelihood and severity of future problems. if we are to do this on a sustainable basis, we need to look beyond rule - making, as important as that is. in particular, any set of rules needs to be accompanied by strong risk management frameworks, both within financial institutions and within the regulatory community. a critical element of these