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

Introductory statement by Mario Draghi, Chair of the ESRB Brussels, 16 January 2012

Dear Madam Chair,

Dear Honourable Members,

I am very pleased to appear before this Committee today for the first time in my capacity as Chair of the European Systemic Risk Board (ESRB).

There are three main issues that I would like to address today. First, I will give you a brief overview of the current situation and present the ESRB’s call for prompt and well-coordinated action. Second, I would like to introduce two new ESRB recommendations: one on mandates for macro-prudential authorities, and the other on US dollar funding. And finally, I shall briefly comment on some of the policy issues on which Parliament has been working and which are of relevance to the ESRB.

Current situation: ESRB calls for immediate action

First, the current situation. When my predecessor, Jean-Claude Trichet, addressed this Committee last October, he characterised the current crisis as one that had reached “systemic dimensions”. Since then, the situation has worsened further. We are in a very grave state of affairs and we must not shy away from this fact.

During the last few months of 2011, uncertainty over the sustainability of certain sovereigns and the resilience of the financial system, coupled with dismal growth prospects, led to severe disturbances in the normal functioning of financial markets and, ultimately, the real economy.

In an attempt to counteract such developments, policy-makers have acted. Central banks have intervened decisively, easing monetary conditions, in particular by widening admissible collateral and lengthening the maturity of operations.

The euro area Heads of State or Government have agreed on an important “fiscal compact” and on stronger coordination of economic policies.

However, decisions without matching actions are not enough and due care should be taken to implement measures in the correct sequence:

We need to address two aspects. First, we need to restore confidence in sovereigns and ensure that EU firewalls are operational and well equipped with an effective and flexible mandate. For this, it is vital that the commitments made by the Heads of State or Government are implemented promptly and fully – particularly, but not exclusively, in relation to the EFSF and the ESM. As the ESRB has highlighted, broadening the EFSF’s capacity could facilitate the recapitalisation of banks in non-programme countries. Only if this comprehensive package is implemented in a reliable manner, and communicated clearly, can other efforts succeed.

Second, we need clarification about the robustness of the EU financial system. The EBA’s proposal for restoring confidence in the resilience of the financial system should not be pursued at the expense of adequate lending to the real economy or exacerbated market fragilities. In this regard, I reiterate the ESRB’s message that the EBA’s recommendation should be achieved primarily through an increase in capital levels, and that due attention should be paid to avoid a disorderly or excessive deleveraging process. National supervisors must avoid such an unwanted outcome. To mitigate potential negative cross-border spillovers, national and European authorities must work together to assess ex ante the effects of planned actions at the level of the institution, the country, the region and the Union as a whole. Authorities should strive to minimise potential negative cross-border spillovers and to communicate coherently and in unison.

I cannot underline these points enough. Only a well-coordinated, coherent and properly timed strategy will yield the desired results.

ESRB publishes recommendations on macro-prudential mandates for national authorities

Let me now speak about the ESRB’s new recommendations. Today, the ESRB has taken an important step in fostering the establishment of adequate policy frameworks by publishing recommendations on macro-prudential mandates for national authorities.

These recommendations are designed as guiding principles for the development of macro-prudential frameworks in the Member States, balancing the need for consistency among national approaches and flexibility to accommodate national specificities.

The ESRB recommends that, when setting the framework, Member States define properly the objective of macro-prudential policy as that of safeguarding the stability of the financial system as a whole. Ultimately, the aim is to ensure that macro-prudential policies can be undertaken at the national level, for instance in response to ESRB recommendations.

The ESRB considers it important for national legislation to identify clearly the authority responsible for macro-prudential policy, either as a single institution or as a board composed of the authorities whose actions have a material impact on financial stability. While not jeopardising their independence, central banks are expected to play a leading role in such an authority.

The macro-prudential authority should be given the tasks of identifying, monitoring and assessing potential risks to financial stability and should then act accordingly to address those risks by implementing appropriate policies. For that purpose, the authority should be able to access the relevant information and should be in control of the appropriate instruments.

Finally, the authority should be independent, accountable to national parliaments and perform its duties transparently.

The ESRB calls on Member States to implement these recommendations before 1 July 2013 and to communicate by June 2012 their intentions with respect to implementation and on developments to date.

… and on US dollar funding

Today, the ESRB has also published recommendations on US dollar funding of credit institutions. The US dollar is an important funding currency for EU banks, almost all of which is obtained wholesale and is largely very short-term. There is significant maturity mismatch between long-term assets and short-term liabilities in US dollars. The investor base providing short-term US dollar funds has proved volatile. This combination of maturity mismatch and flighty investors is a key vulnerability.

In 2008, and again starting from mid-2011, we have witnessed strains in US dollar funding markets. Such elevated tensions could have an adverse systemic impact on EU banks’ solvency, if US dollar-denominated assets were sold at fire-sale prices, and on the real economy, from a scale-back in lending.

Although central banks’ swap lines have helped to comfort market participants and reduced tensions, their existence might also imply a moral hazard risk, hindering EU banks from adopting a more robust funding structure.

In order to avoid a similar level of stress in US dollar funding in the future, the ESRB recommends that national supervisors:

  1. monitor closely banks’ funding and liquidity risks in US dollars and, where appropriate, limit those risks before they reach an excessive level;
  2. ensure that banks’ contingency funding plans (CFPs) include management actions for handling shocks in US dollar funding and that these plans are appropriate from a systemic perspective.

An important benefit of the recommendation is that it will support supervisors in their efforts to identify the accumulation of excessive funding risks in US dollar and take preventive measures to address potential systemic risks.

The recommended enhancement of CFPs will contribute to EU banks’ resilience against stress in US dollar funding markets and help banks to internalise funding and liquidity risks. From a macro-prudential perspective, it is important that the recommendations aim to mitigate systemic risks due to simultaneous actions by EU banks in the event of market stress, thereby avoiding a disorderly unwinding of financing structures.

ESRB recalls the macro-prudential relevance of certain regulatory initiatives

Let me finally turn to some legislative proposals on which this Parliament has been working as co-legislator over the last few months.

Again, as President Trichet said when he was here last October, the ESRB “stresses that national macro-prudential authorities of EU Member States must be able to tighten settings of prudential instruments to levels above those provided for in EU legislation in a timely fashion and based on local economic conditions.” This is possible without jeopardising the single market and particularly important when it comes to current proposals for regulations on banking (CRD/CRR).

The same principle applies to the EU regulation on OTC derivative transactions, central counterparties and trade repositories (EMIR), which the ESRB welcomes. However, also here, it is important to view certain tools – margin and haircut requirements – as a part of the macro-prudential toolkit.

The ESRB has written to Members of this Parliament on both the CRD/CRR and EMIR proposals separately to offer macro-prudential perspectives that may be taken into account during the legislative process.

Finally, the ESRB acknowledges Parliament’s work on the proposed directive on credit agreements relating to residential property. This initiative is an important step in improving both consumer protection and the availability of prudential tools to national authorities. Such prudential tools may then be used for macro-prudential purposes, dampening otherwise damaging property price cycles.

Thank you very much for your attention.