Press Release - The importance of a genuine banking union for monetary policy - Speech by Peter Praet, Member of the Executive Board of the ECB, at the EMU Forum 2016, Oesterreichische Nationalbank, Vienna, 24 November 2016
It was always understood that deep financial integration would be key to effective macroeconomic stabilisation in Monetary Union.
The cross-border integration of credit and capital markets would facilitate a smooth transmission of the single monetary policy across the union, allowing the central bank to stabilise area-wide shocks. And the risk-sharing benefits of financial integration would help absorb local macroeconomic shocks that could not, by definition, be addressed through monetary policy – nor, by design, through a federal euro area budget. Indeed, financial risk-sharing would be crucial to prevent national budgets from being overburdened in severe local downturns.[1]
These benefits are one reason why, 15 years ago, the topic of this conference was “The Single Financial Market – Two Years into EMU”. At that time, however, it was widely believed that the elimination of intra-EMU currency risk, coupled with a process of broad economic and regulatory convergence, would foster a market-led process of financial integration. And indeed, following the launch of the euro, financial markets did steadily integrate, in particular the money market but also bond markets. The integration of the banking sector deepened too. According to the ECB’s financial integration indicators, euro area interbank markets became almost completely integrated prior to the crisis.[2]
Yet, as is well-known, the state of pre-crisis financial integration was shallow and largely illusory.[3] Under stress, the euro area financial market fragmented, providing little ex post risk sharing. This was made possible by the composition of cross-border flows – based more on short-term debt than on equity – which limited the potential for capital-market risk-sharing. And the integration of interbank markets was not matched by retail banking integration, hindering consumption smoothing through credit markets. Financial fragmentation in turn disrupted both monetary and fiscal stabilisation as public and private sector borrowers suffered the effects of the so-called “bank-sovereign nexus”.
This failure of financial integration, and its effect on shock absorption, is an important reason why the crisis has been more protracted in the euro area than in other advanced economies. Hence a strong policy response has been needed. First, to make the financial sector safer by strengthening the regulatory and supervisory framework – what has been termed “risk reduction”. And second, to deepen risk-sharing by creating the institutional conditions for more robust financial integration, which has been one key aim of the banking union. It is this latter aspect, and why it matters for monetary policy, that I would like to focus on in my remarks today.
The main point I would like to make is that we need a more integrated banking sector in the euro area to achieve greater macroeconomic stability. But to achieve this, private and public risk-sharing have to be seen as complementary – that is, we cannot expect to have a fully integrated banking sector that can share risks without common institutions that can also share risks, namely for deposit insurance and bank resolution. Without such institutions, there is a real prospect that the banking system will remain fragmented, and that is ultimately to the benefit of no one in the euro area.
Financial integration and monetary policy transmission
Why is financial integration in the euro area, especially in the banking sector, and the resulting degree of risk-sharing so important for monetary policy? The financial system helps smooth out temporary fluctuations in economic conditions. Companies and households can resort to financial intermediaries – in the euro area, typically banks – to accommodate their temporarily higher financing needs and reduce fluctuations in spending patterns. This leads to a higher degree of macroeconomic stabilisation.
A sound financial system reduces the burden on monetary policy, which would otherwise have to step in to stabilise the economy. While banks in principle help to stabilise investment and consumption patterns, they can also contribute to procyclicality by becoming shock amplifiers or even trigger financial shocks. One of the main lessons of the crisis was that in order to effectively transmit monetary policy impulses to the real economy, banks need to be well capitalised through the cycle and conduct maturity transformation in a prudent manner.
Directorate General Communications
Sonnemannstrasse 20, 60314 Frankfurt am Main, Germany
Tel.: +49 69 1344 7455, E-mail: media@ecb.europa.eu
Website: www.ecb.europa.eu
page source http://www.ecb.europa.eu/
