Hearing before the Committee on Economic and Monetary Affairs of the European Parliament

Introductory statement by Mario Draghi, Chair of the ESRB
Brussels, 23 March 2015

Mr Chair,

Honourable Members of the Economic and Monetary Affairs Committee,

Ladies and Gentlemen,

It is a great pleasure for me to update this Committee on the work of the European Systemic Risk Board, in my capacity as Chair of that body.

The potential for widespread financial distress remains one of the main threats to economic recovery. The ESRB plays a key role in mitigating the risk of disruption to the financial system in the European Union. In this sense, the activities of the ESRB – developing structural and cyclical macro-prudential policies and coordinating their implementation across the EU – ultimately help to improve the welfare of European citizens.

Today, I would like to focus on two important developments. First, I will give an overview of the many substantial macro-prudential policy measures that have been taken in the EU since the new capital rules for banks became applicable 15 months ago. Second, I will discuss the ESRB’s recently published report on the regulatory treatment of sovereign exposures. I will then conclude by highlighting ongoing work regarding the macro-prudential framework for non-banks.

Macro-prudential policy after the introduction of the CRD and CRR

The Capital Requirements Directive and Regulation, which became applicable at the beginning of 2014, represented a landmark innovation for macro-prudential policy in the EU. The rules gave authorities a new set of policy instruments with which to address financial stability risks. In addition, under the rules the ESRB was charged with new tasks, such as developing guidance on the use of certain instruments – as it did for the counter-cyclical capital buffer in June last year – and issuing opinions on the use of instruments – as it has done for a measure taken by the Belgian central bank regarding real estate lending.

When I appeared before this Committee in November, I referred to some early developments in the use of macro-prudential instruments. Now that the new capital rules have been in force for more than one year, I can paint a more detailed picture.

Since the beginning of 2014, about 45 new macro-prudential policy measures have been taken in the EU, under the guidance provided by the ESRB in its Flagship Report and Handbook on macro-prudential policy in the banking sector. This list includes the activation of capital instruments available under the CRD and CRR, as well as other instruments available under national legislation, such as loan-to-value limits. In addition, another 45 minor administrative measures have been issued. The ESRB publishes a catalogue of all 90 measures on its website. This catalogue, which is updated periodically, reflects the ESRB’s role as a central hub for information regarding macro-prudential policy in the EU.

Let me give you an impression of the content of these new macro-prudential policy measures. Around half of the 90 measures have economic substance. The remainder, such as the early introduction of the capital conservation buffer or the setting of a counter-cyclical capital buffer rate at 0%, are of a more administrative and procedural nature. Roughly half of the 90 measures have been taken by just four Member States: Denmark, Slovakia, Sweden and the United Kingdom. Some Member States did not take any measures in 2014, including France, Germany, Italy, Poland and Spain.

The large majority of measures are of a tightening or “conservation” nature. Most of them – about 85% – aim to address concerns related to credit growth and leverage. The remaining measures tackle systemic risks arising from banking groups that are large and complex.

A number of Member States introduced measures aimed at maintaining the regulatory capital levels that existed before the CRD and CRR entered into force. Other measures are not yet binding, but this may change as the financial cycle develops.

The real estate sector features prominently in the measures taken – for example, in terms of adjustments to the risk weights applicable to real estate lending, as well as loan-to-value and loan-to-income limits. This wide variety of measures is quite normal, since macro-prudential policy is still at an early phase of development. In this spirit, the ESRB is conducting further work on the use of macro-prudential instruments to address potential systemic risks emanating from real estate. At my next hearing, I intend to provide greater detail on the outcome of this work.

In discussing these measures with national authorities, the ESRB has observed that the analysis of possible cross-border effects is usually limited. Furthermore, national measures are reciprocated by other Member States only rarely. Let me please make here two examples. First, I would like to congratulate the authorities of the Netherlands for having decided to reciprocate the above mentioned measures of the National Bank of Belgium, through which risk weights on certain mortgages in Belgium have been temporarily increased. Thanks to this reciprocation decision, Dutch banks lending to residents in Belgium will be subject to the same macro-prudential conditions. Second, last year Estonia imposed a systemic risk buffer on its own banks to tackle certain structural vulnerabilities, and invited the macro-prudential authorities of Northern Europe to reciprocate, to avoid that its measures would be by-passed through lending from large foreign banks; discussions are still ongoing, and I would urge authorities of other countries to take that request in serious consideration.

I believe that reciprocation is useful, as it fosters a level playing field and reduces the risk of the effectiveness of measures being eroded by the activities of foreign banks. We need to ensure that the financial stability policies of the Member States across the European Union are uniformly applied, when they address the same vulnerabilities in the same regions. Accordingly, the ESRB is investigating these issues more closely, also in order to hardwire voluntary reciprocation procedures among ESRB members.

Regulatory treatment of sovereign exposures

Now I would like to turn to a specific topic of substantial macro-prudential policy interest: the regulatory treatment of sovereign exposures. In recent years, we have seen that substantial systemic risk can arise from the link between banks and sovereigns. With this in mind, the ESRB has been working for more than two years to critically assess the treatment of sovereign risk in regulation. Earlier this month, the ESRB published its detailed findings.

Sovereign exposures are in many ways treated preferentially compared with corporate exposures in current banking and insurance regulation. For example, sovereign exposures are exempt from the large-exposure regime and are often subject to low or even zero capital requirements. The report argues that such rules underestimate the possibility of sovereign default and therefore do not fully reflect the risks associated with sovereign exposures. Preferential treatment can therefore lead to systemic risks arising from overinvestment in government debt, crowding-out of lending to the economy and the reinforcement of the bank-sovereign link.

At the same time, the report also stresses that any changes to the current framework must be carefully designed and calibrated in order to set the right incentives for financial institutions without increasing pro-cyclicality or creating instability in the sovereign bond market. It examines a number of policy options, which could be implemented on their own or in combination with other policies. These policy options include increasing capital requirements for sovereign exposures and applying large-exposure limits. The policy options are examined in terms of their advantages and disadvantages, as well as their possible impact on financial institutions and markets.

I would like to emphasise that the report is concerned with ensuring financial stability in the long-term, not with addressing any immediate difficulties. Also, it is necessary to achieve progress at the international level on the same issues. The policy options presented in the report would only be implemented once the situation in sovereign bond markets has normalised, and in the framework of a review of the Basel Accord.

Indeed, the ESRB report will be a useful reference point not only in Europe, but also in global institutions such as the Basel Committee on Banking Supervision, which has recently initiated a review of the parts of the Basel Accord related to sovereign risk. I therefore trust that the report will help to foster a discussion which, in my view, is long overdue.

Looking ahead

Mr Chair, Honourable Members, let me conclude with some general reflections on macro-prudential policy.

Since the ESRB was established towards the end of 2010, macro-prudential policy has come a long way. Responsibilities have been assigned to macro-prudential authorities across the EU, following the ESRB’s recommendation in 2011. Thanks to the Capital Requirements Directive and Regulation, these macro-prudential authorities have been given substantial powers. Macro-prudential policy-making is now “alive and kicking”, as is apparent from the 90 measures which have been taken in just over one year.

The ESRB continues to reflect not only on the macro-prudential policy stance, but also on whether the macro-prudential policy framework is adequate. This includes structural topics, such as the regulatory treatment of sovereign exposures. It also includes the extension of macro-prudential policy to non-banks, which play an increasingly important role in Europe’s financial system.

The ESRB is progressing with work on developing macro-prudential policies for financial market activities and non-bank financial entities, including shadow banks. Let me give one example. The ESRB is aware that a systemic risk of vicious liquidity spirals – whereby funding and market liquidity interact, generating contagion – still exists. To mitigate this systemic risk, macro-prudential authorities could consider setting conservative minimum or time-varying margin requirements, in order to reduce the risk of a sudden increase in margin requirements. Such a macro-prudential policy could be applied both to over-the-counter and centrally cleared transactions. Although this work is at an early stage, I believe that it has the potential to be an important extension of the macro-prudential policy framework.

Thank you very much for your attention.