European Central Bank council member Ewald Nowotny comments on the sovereign debt crisis, the economic outlook and ECB policy.
Nowotny, who heads Austria’s central bank, made the remarks in an interview in his office in Vienna yesterday.
On the debt crisis:
“Definitely, the crisis is not over. That, I think, is pretty clear. On the other hand, I think one should not give too much weight to short-term developments. But one has to admit that also from the medium-term we have some elements that are not too positive. For me one important element is the real growth perspective, which for the euro zone as such is slightly negative, which as such is not a good thing. But what of course also is added to the problem is that we have increasing divergences within the euro zone, which of course doesn’t make economic policy easier for the ECB.”
“On the other hand, what we see is that a number of structural policy changes have been undertaken in the countries that have troubles and all these changes need time to produce results.”
“Markets are of course not giving much time. On the other hand, I think policy makers should not be too much market driven and should not engage in only very short-term view but should have some kind of medium perspective, which means that I do not see a need to react to every single market reaction.”
On Emergency Liquidity Assistance:
“Use of ELA has grown in the last months. This is not really intentional, but this is out of the system of the ECB. Because as we have a unified collateral framework, in certain situations banks cannot fulfill the criteria of the ECB collateral and for this we do have this emergency liquidity assistance.
“But we have to underline this is not to be seen as a permanent second line of monetary policy. As is expressed in the name, it is emergency liquidity assistance. So this is not something that should be seen as a permanent instrument for various countries.
“There is an information process for this with the ECB Governing Council and in the course of this information process there always has to be given a clear perspective for these banks. It has to be clear that these have to be viable banks. So therefore also there has been an increase in the role of ELA. This doesn’t mean that we are now establishing kind of a second line of liquidity provision.”
“These ELA operations are always done on a very specific individual basis and have to be explained for each individual bank for every month again. So this isn’t something permanent, but every month again a national central bank that has the intention of granting an ELA to a specific bank has to bring up this case again with the ECB Governing Council.”
“In all cases when you grant ELA you have to explain the conditions of the exit, so this is never done as a permanent measure, it is always done as a measure with a certain limited period of time.
“We have a very clear knowledge about the volume of ELA. We know to whom it is given and also it is in the responsibility of the specific national central bank. We do have an overview of this at the ECB level.”
On potential future LTROs:
“Every loan has to be refunded. It is also, I think, obvious that these LTRO operations are part of our non-conventional arsenal. So therefore there is no intention to move it to the conventional part. But for this specific policy with this regard, this is really something again -- we never pre-commit. So it has to be seen according to the policy needs. But one should be aware that also it is of course a three-year loan: it is a loan. So therefore at the end of the day there has to be a refinancing.”
On the economic outlook:
“It is true that for the world economy in general the perspectives have worsened. This relates to all parts of the world economy including Europe.”
“Europe and the euro zone are important players of the world economy, but we are not the only players and we see a number of risks also in other regions. But in general one has to be aware that the growth dynamics of this year and maybe also of next year is going to be lower.
“I don’t think that they are increasing, but the downside risks that we had mentioned at an earlier stage have been materializing.
“What we see is -- and this is in line with the risks that we had been aware of -- that growth dynamics for the euro zone as such are tending to be lower than we had been expecting at the start of the year, and on the other hand inflation also tends to be lower and what we see is that divergences in the economic dynamics between member countries of the euro zone unfortunately have a tendency to increase.
“And this of course is a challenge, but this is typically a challenge that cannot be met by the ECB, but that has to be met by the countries involved.”
On room for further action:
“You know there is a long theoretical debate about the room to maneuver for a central bank in a world of low interest rates. The answer of this debate is: yes, there are elements to move, but what elements one uses and what way we go is something that has to be decided at a later stage. And also when comparing the role of the ECB with that of other central banks one always has to bear in mind the specific legal situation of the ECB and the statutes of the ECB. And I think it is a very important aspect of the credibility of a central bank to adhere to the legal structure that has been given to it.
“This refers especially to aspects of buying government bonds directly on the primary markets. The SMP program was about correcting imbalances on the secondary markets. But we have clear legal ban with regards to buying on the primary market. And so this is not only an economic discussion, but also a legal discussion, but one has to take this legal aspect seriously.”
On granting the ESM a banking license:
“I am not aware of specific discussions within the ECB at this point but it is of course a discussion we have at the European level. I think there are pro arguments for this, there are also other arguments, but I would see this as an ongoing discussion. It is not something that is only in the field of monetary policy, so this is part of a broad discussion. We never give specific comments on the discussions of the Governing Council.”
On the deposit rate at zero:
“It had a very substantial effect, for me it was surprisingly substantial. The money deposited with the ECB has gone down considerably in the deposit facility, because it makes no difference for the banks to keep it in the deposit facility or in the current account. Whether it will have further effects, for instance that banks or money-market funds are prepared to go to the interbank market and are prepared to take a little higher risk in search of some return, for me this would be a logical step. We see some tentative signs in this way, it’s still too early to give a clear picture.
“One has to see that the months of July and August may not be the typical months in the money markets, we have a bit to wait. As a tendency, I could imagine we get more action again in the money markets, and of course that doesn’t say all markets involved. It would be a first step.”
“We do not have experience of course with negative deposit rates. Some central banks are experimenting with this, for instance the Danish central bank. A central bank has a number of other alternatives to influence money markets in addition to interest rates, there might be some technical problems to applying negative rates for the deposit rate. For the time being this is not a practical aspect that is being discussed.”
On changing the rate on excess reserves in current accounts:
“Every good central bank should be able to develop a number of ideas, a number of ideas are floating around. I do not see a need for immediate decisions in that respect.
“One should not look at this in the narrow sense of central bank policy. One has to see that the problems of money markets are problems of not having enough trust in the banking sector. For me the fundamental aspect is how to increase the credibility of the banking sector. One ongoing point is to strengthen the capital base. We have had the EBA capital exercise, it is clear this will not be a one-shot affair. But the ratios that have been achieved in the follow up to that are here to stay, there should not be a downward movement again.
“I see also the discussion of the European banking supervision scheme as a very important step to increase the confidence of the banking sector. These are the fundamental elements that will influence the money markets, these institutional changes, not the field of monetary policy.”
On bank supervision:
“The single European supervisor is a very big step. At the end of the day it is a transfer of sovereignty in a very sensitive field of economic policy. Therefore it is a step that needs really serious work to be done, I hope that this ambitious timetable can be fulfilled. I personally very strongly advocate that our first priority should be to build a high quality, stable system. Quality is more important than velocity.
“The main driver for this is the EU commission. They are now in the process of getting a clear view of the first principles: Who should be the member countries -- is it the EU 27, the euro 17, something in between? I do not really see the 27 as a realistic perspective, but it depends from where you start. You could have opt outs or opt ins, that sort of thing.
“You have the question of what kind of banks do you supervise, do you concentrate on the biggest banks, or do you think that it has to be an encompassing scheme for all banks. This makes a huge difference with regard to the technical approach that you take. Then there’s the question of what’s the role of the ECB in this, both from the supervisory side and there’s also the monetary policy side.
“From the point of view of the ECB, our prime objective is monetary policy. There can be no compromise in that regard. One can combine the two, but in a way that does not have negative effects on our primary tasks. I expect that these basic questions will be answered in September when the Commission gives their first proposals, then there will be a need for a political process to discuss this, and then you have to do the technical side.
“Banking supervision is an activity with a high degree of responsibility and also a high degree of public visibility. So therefore one has to take this very seriously, and I would be very careful not to engage in an activity that is not fully well prepared. We all know it has to come, there’s a basic consensus. But it has to come in a well prepared way.
“My personal view is that we should have a unified banking supervision both for the big and the small banks, so not a two-tier system with regard to the regulatory aspect. But with regard to the operational aspect, there will be a need for a two-tier system. In the sense that for the smaller banks the prime operational side for technical reasons has to be with the national supervisors. Only they have the manpower, the local knowledge, the direct access.”
The ECB “always has to have the right to intervene in specific cases” and some specific controls will be needed “to ensure there are uniform standards applied in Europe. If we have this encompassing view, then it is possible to have supervision out of Frankfurt, but you have to work with the local supervisors.
“If I take for instance the experiences we’ve had just now with Spain, at a certain period of time, in addition to the local regulator, some outside experts have been called in to do additional expertise, I could imagine that this is a kind of model that we would have. I could imagine that in ordinary situations it is the local supervisor, but when some specific questions come up, additional expertise might come in from outside. A private sector company could be hired by the supervisor, there’s no need to do this from the public side, this is a model that could be discussed in detail.
“At the EU summit there was a clear distinction between the role of the supervisor and only the supervisor was discussed. There was no special mention of aspects of bank resolution and no discussion of the aspects of European-wide deposit insurance. There’s a clear policy signal that the time is not ripe for those two things.
“Looking at it from an economic point of view, there is of course a certain interconnection between those two aspects. If you have European banking supervision this could at the end of the day include decisions of closing down banks, and the costs of this would still have to be borne by the national taxpayer.
“This is a possible approach, but not, I would say, the final equilibrium approach. I think now we have to start with the first step, and we will see developments at a later stage. This has to be seen in the broader view of European fiscal union, which of course is something that is still a very long time perspective.”
“Our working assumption is that Greece will be able to fulfill their requirements, but it is obvious that this will need quite substantial efforts from the side of the Greek government. This is part of the discussions that Greece will have with the institutions. The results of the Troika discussions will only be available end of August/mid-September.”
On the ECB’s stance on bailing in senior bank bondholders in restructurings:
“This is not a general discussion, this only refers to banks that are in a process of reorganization. It’s not only for banks that are shut down, the discussion also includes banks that are in a process of reorganization. Still, this is a very limited element.
“One has to be aware there is an increasing discussion about the division of the burden borne by the taxpayer, and that borne by certain kinds of investors, that invest in higher risk assets that bear a higher interest rate. They are aware that this is not a fully guaranteed asset, otherwise it would make no sense for this risk premium to be paid out. Markets aren’t always driven by logic, and one has to be aware of practical effects. I welcome this discussion because it is important not automatically to put the entire burden on taxpayers.”