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

Introductory statement by Mario Draghi, Chair of the ESRB, Brussels, 26 November 2018

Mr Chairman,

Honourable members of the Economic and Monetary Affairs Committee,

Ladies and gentlemen,

It is a pleasure to address you for the second time this year in my capacity as Chair of the European Systemic Risk Board (ESRB).

I would like to focus today on two topics. First, I will talk about some of the findings of the ESRB’s work on the commercial real estate sector. I would then like to touch upon the ESRB’s proposals regarding macroprudential tools for insurers.

Let me start with the commercial real estate sector. This sector is important for financial stability not only because of its size but also because of its strong interconnectedness with the financial system and other parts of the real economy. For these reasons, it is important that macroprudential authorities closely monitor developments in commercial real estate. Today the ESRB publishes the findings of its monitoring exercise for this sector, and I would like to share with you some of the main themes of our report.

While banks remain an important source of funding for commercial real estate in most EU countries, non-banks and international investors are playing a larger role in this market than they did before the crisis. Insurance companies, pension funds and investment funds are now the largest holders of euro area commercial real estate bonds, for example.

The increasing share of cross-border and non-bank financing of commercial real estate has some positive aspects. In particular, it has the potential to increase overall risk-sharing as any losses from commercial real estate can be spread across a number of entities and countries. Furthermore, in the event of distress in the domestic financial sector, access to foreign banks and other institutions provides alternative sources of finance. The ability to attract capital inflows at such times may, therefore, shorten the downturn and foster the subsequent recovery.

However, the shift I just described can open up new channels for commercial real estate shocks to be transmitted to the financial sector and the real economy. Some of the non-bank institutions, such as open-ended real estate investment funds, might face redemption pressures that can lead to commercial real estate price corrections if institutions are forced to sell their assets quickly. The presence of foreign investors - for whom, among others, we do not have sufficient statistical evidence - can also increase the risk of rapid price corrections, since they may decide to remove their funds suddenly if yield prospects become more favourable elsewhere, if market uncertainty rises or if they engage in regulatory arbitrage. Foreign investors may also cause countries’ commercial real estate cycles to become more synchronised and more vulnerable to global risk factors.

Macroprudential authorities seeking to address vulnerabilities related to commercial real estate have various instruments at their disposal, although these are concentrated on the banking sector. Only a few of these tools have been implemented so far, with increases in risk weights for commercial real estate exposures being the most commonly applied measure. In three countries, borrower-based measures covering commercial real estate exposures have also been implemented. In addition, some countries have activated macroprudential buffers, such as the systemic risk buffer and the countercyclical capital buffer, for the purpose of targeting commercial real estate-related vulnerabilities.

The growing role of non-banks in financing commercial real estate confirms the need to develop appropriate macroprudential tools targeting all parts of the financial sector. The ESRB continues to work on developing macroprudential policy beyond banking. In this vein, the ESRB is today publishing a report discussing how to strengthen the regulatory framework for insurers.

A healthy insurance sector contributes to financial stability. By taking on risks, insurers remove the possibility of large losses for households and companies; and by matching long-term savings and investment, they contribute to economic growth. However, the behaviour of insurers can also contribute to the build-up of vulnerabilities in the financial system. The ESRB thus believes that authorities should have an appropriate macroprudential toolkit at their disposal to target systemic risks in insurance, looking beyond individual institutions. Let me briefly highlight some of our main proposals in this regard.

First, authorities should be able to impose market-wide capital increases and dividend restrictions. This would enable them to enhance the resilience of insurers in the event of unfavourable market developments. Such capital increases could target specific entities and/or activities.

Furthermore, it cannot be ruled out that there might be times when policyholders want to terminate their insurance policies in large numbers, thereby putting liquidity strain on insurers. Authorities should be able to protect financial markets and the policyholders themselves from the adverse impact of such an exceptional run on insurers. One way of doing this would be to consider temporarily preventing policyholders from terminating their contracts. Last time we met, I discussed a similar tool for investment funds.

A macroprudential toolkit for insurers should perhaps also include time-varying countercyclical capital requirements. Such requirements could reduce the incentive to sell off assets by lowering capital requirements during downturns. They could also help prevent the build-up of sectoral vulnerabilities by increasing capital requirements during upturns.

It is also important to ensure the consistency of macroprudential policy by extending certain instruments used in the banking sector to insurers performing bank-like activities, such as mortgage lending or commercial real estate financing, which we just discussed.

Let me conclude by saying that there is more work to be done here too. In particular, we need to decide how to calibrate these instruments, which thresholds should apply and how these instruments should be incorporated into the current regulation. The ESRB will continue discussing these issues and will contribute to the review of the Solvency II Directive, thus also helping this Committee to decide on the future shape of the regulatory framework for insurers.

Thank you for your attention. I am now available for questions.