NEWS Release - The state and prospects of the euro area recovery - Speech by Mario Draghi, President of the ECB, at the European Banking Congress, Frankfurt, 18 November 2016
Since the onset of the global financial crisis, 2016 has been the first full year where GDP in the euro area has been above its pre-crisis level. It has taken around 7.5 years to get there.
The economy is now recovering at a moderate, but steady, pace. Employment has grown by more than four million since its trough in 2013. And the recovery has become more broad-based, with less difference in economic performance across countries.
What we have now to ask is what are the factors that have allowed the recovery to gather steam, and whether we have reason to believe that they are sufficient to deliver a sustained adjustment in the path of inflation.
We have witnessed many encouraging developments, not least the healing of the euro area banking sector, which has allowed credit growth to turn positive again and monetary policy transmission to strengthen. This is a necessary condition for a full return to macro-economic and price stability.
But despite the uplift to prices provided by the gradual closing of the output gap, a sustained adjustment in the path of inflation still relies on the continuation of the current, unprecedented financing conditions. It is for this reason that we remain committed to preserving the very substantial degree of monetary accommodation, which is necessary to secure a sustained convergence of inflation towards level below, but close to, 2% over the medium-term.
What I would like to do in my remarks today is explain these perspectives – the factors that have put the euro area economy on a stronger footing, but also the reasons why we cannot yet drop our guard.
New factors making the euro area economy more robust
The first development that gives us comfort is the improving solvency of the banking sector.
We need a strong banking sector to support the economy through the recovery. But if there is one lesson we can draw from the past decade, it is that to be genuinely robust, the banking sector must be well-regulated. Indeed, there is a widespread agreement that one of the main causes of the global financial crisis was the excessive deregulation of the financial sector in the previous two decades.
The financial origins of the crisis explain in turn the slowness of the economic recovery. Banks that overextended credit in the upswing had to clean up their balance sheets and strengthen their capital. Firms and households that took on excessive debt had to deleverage. And that combination depressed both credit supply and demand.
So the re-regulation of the financial sector is in fact a part of the growth agenda. And major progress has now been made in redressing the mistakes of the pre-crisis era.
The global regulatory agenda, steered by the G-20, has made the sector considerably more robust in terms of capital, leverage, funding and risk-taking. Common Equity Tier 1 ratios in the euro area have improved substantially, rising from less than 7% for significant banking groups in 2008 to more than 14% today. Leverage ratios are now close to 4% for large banks. The Liquidity Coverage Ratio was implemented last year, and most euro area banks are already complying with the Net Stable Funding Ratio ahead of its implementation in 2018.
It is true that this regulatory agenda, which has evolved profoundly in its design over the past eight years, may also have created some uncertainties, for instance over steady state capital levels, which are reflected in bank share prices. Indeed, uncertainty over future capital requirements can give rise to a risk premium, which weighs on banks’ cost of finance and acts as a deterrent to expanding activities or supplying credit to the economy.
So now is the time to finalise the regulatory agenda and enter a period of stability. The focus should be on implementation, not on new design. Regulatory measures should be implemented in a balanced way that ensures a level playing-field globally. And while marginal adjustments are possible, there should be no rolling back on what has been decided.
Re-regulation has led to welcome improvements in bank solvency. Meanwhile, asset quality has also improved. The non-performing loan (NPL) ratio has been decreasing in the euro area, even if modestly. Critical in this context was the Comprehensive Assessment of bank balance sheets – including an asset quality review of great depth – which encouraged banks to frontload the strengthening of their balance sheet. While NPLs remain high in some countries, the problem today is more related to profitability than to the robustness of balance sheets, since coverage ratios are close to 50% and much of the remainder is collateralised.
All this progress has gone hand-in-hand with a steadying economic recovery. Increased banking sector resilience has helped shield the recovery from external shocks and sustain its internal momentum. The banking system has been able to weather, among other things, the crisis in emerging market economies, the collapse in oil and commodity prices, and the consequences of the UK referendum. And healthier banks have provided the necessary supply of credit to maintain the pace of the recovery.
The easing in credit supply conditions has been visible in both lending rates and lending volumes. Since mid-2014, bank lending rates have fallen by almost 100 basis points for both euro area households and corporates. Small and medium-sized enterprises have benefitted from even larger declines. Lending volumes, in turn, have posted positive growth rates for households since end-2014, and for non-financial corporations since the last quarter of 2015, following multi-year declines.
And financing conditions have improved in capital markets too, which has been followed by a pick-up in corporate bond issuance.
This credit reversal has in turn supported a second benign characteristic of the recovery: the fact that it has become increasingly driven by domestic sources of growth.
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