Third ESRB annual conference: Keynote speech: P. Lane

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Third ESRB annual conference: Keynote speech: P. Lane
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Third ESRB annual conference - 27/28 September 2018 Keynote speech Philip Lane, Governor, Central Bank of Ireland, Chair of the ESRB ATC Philip Lane, Governor of the Central Bank of Ireland and Chair of the ESRB Advisory Technical Committee, gave a keynote speech to conference participants.
okay yeah good afternoon let me say how pleased I am to have the invitation to speak to this event this
afternoon let me by the way before I dive into my remarks make the link to what we just heard so I'm going to go much more to the short term at dimension of macro dental policy but there is a link which is if well we noticed you last ten years which is that one reason maybe why all of the action on say climate change has been delayed was dealing with the crisis and you know of course if you have a financial crisis everything else is put on hold so you know I gave a speech during the summer basically making this point you have to have a short-term stability in order of the oxygen and the space to tackle long-term issues whether its climate change or the implications of aging for the financial system so that's my bridge between that session and what I want to talk about I think again before I get going on on the two points I want to make the fact that currently I'm the chair of the Advisory Technical Committee of the ESRB means I get to see a lot of the work in progress across the system and previously before I took on my current job as chair of the Advisory Scientific Committee so the ESRB means a lot to me and let me emphasize is when we think about this the work who does all the work behind at what you see in the website it's the Secretariat it's the staff of the ECB the staff of the various national competent authorities the staff of the European Supervisory authorities and the Commission when I chaired the Task Force on safe assets last year again if you go to that you just see what what's possible when so many people so many institutions can come together but today I want to focus on two points one is what is the role of Mack potential policy in an upswing so we know now in your we're solidly in a phase of economic expansion and that the question is should the stance of macro-prudential policy respond and then second a bit similar to present Draghi's point earlier on we know now that with the more and more of the assets of the financial system intermediated true non banks how do we think about macro-prudential policy how do we think about monetary and financial stability vzv the non-bank financial system so if I think about the the first question which is the upswing in the financial cycle well this is really in many ways at the the time has come for the es or B that one reason why the ESRB was set up was the recognition that at the last crisis and indeed many historical crises have been driven by excessive leverage during the off cycle so when you have excessive leverage there's increased vulnerability to negative shocks and if such a shock occurs it also makes it more difficult more costly to resolve a crisis you get more persistent there downturns and a lot of it difficult a cost associated so we know that that's I think the consensus view of the crisis we've had if you go back to labor in Valencia Reinhardt Rogov sure I can Taylor it's really an age-old story and again if he people who look at the mid-2000s and they say well the counterfactual what if we had the toolbox we have now and we had that toolbox and it was used in the mid 2000s let me cite two papers one is the American Economic Review paper by Philip Martin and Thomas Philipp on which came out last year and that's a very nice paper about the euro area about individual countries in the euro area and they're basically able to do a very nice empirical study where if limits on leverage had been imposed the scale of the boom and bust cycle would be much milder the costs would have been a lot less equally at the recent a Bank of England paper which shows that that again if we had limited leverage about the financial system and of households in the mid-2000s the crisis creed have been avoided or mitigated so I think we now have a very solid evidence that the alternative to having mocked potential policy we've tried that so that maybe let's try this time to actually use it so President Draghi mentioned earlier on that more and more countries are turning on different measures so the counter cyclical capital buffer is being turned on in different countries we turned it on this summer of course with a one-year lead time you announced now that takes effect one year from now and across all of the countries associated with the ESRB at twenty countries have also introduced borrower based measures I'll come back to the link between those measures and the cycle in a couple of minutes now the logic of the counter cyclical capital buffer is straightforward if an additional capital buffer is imposed during up swings then this should make the banking system more resilient in a future downturn because that capital buffer can be switched off the extra capital accumulated during the upswing can be released and therefore the kind of a procyclical deepening the recession type of withdrawal of credit supply that at some banks engaged in to preserve capital in a crisis that can be avoided so 3d it's really it's a resilience issue in that when the Sun is charming prepared for the rainy day now one basic point here and this has motivated us in how we decided to switch this arm is this should be done early because if you wait too long especially when there's one-year lead time you maybe two days so in assessing at the timing how much evidence do you need to accumulate how many technical indicators need to be flashing at you our assessment and I cited it in the written speech which is on the central bank website I cite the work we've put in to show at that the benefits are high of an early switch on and the costs are fairly limited so I think that that's an important point because all these countries are trying to work out how to use this instrument and I think an early switch on I'm convinced by that second eye in calibration so you've decided to switch his arm they can end the question to calibrate how what size of buffer should you look for and so here I think the the natural way to think about this is to think about well how quickly will capital deplete in a downturn in order to keep Bank the banking system safe and resilient what kind of buffer is needed to deal with the cyclical at risk and of course there's there's a close connection with how we think about stress tests in thinking about ours but let me point out two factors that are relevant in that discussion one is I think it's inescapable that a country with a high stock of non-performing loans is intrinsically more exposed to cyclical risk I mean just say you know we we all believe that the reason they improvement in macroeconomic conditions has been a pretty dominant factor in the decline and non-performing loans across Europe in the last couple of years so if that's true I think it's obviously true then what is true is if we had a cyclical reversal if we had a downturn then some of those non-performing loans which look better may no longer look better may may start to not perform again because essentially in a downturn if people lose their jobs if businesses lose sale sales revenue and so on it's more difficult for a data to maintain compliance with the terms of a loan contract or to comply with the terms of a restructure so especially if there's inadequate provisions for the NPLs I think there's a pretty direct connection between the stock of mpls and the optimal value of the C cyb you need to build a bigger cyclical buffer if you have a large stock of unresolved mpls the second point I want to make is a there's not really a clean division between cyclical risk and structural risk so there was a recent ESRB studied earlier this year about structural buffers and part of that has a discussion about the interaction with the cycle and I think one particular example is imagine you have a systemic risk buffer a structural buffer which is really to capture overexposure to real estate now you can imagine a real estate crash independent of a business cycle it could happen for exogenously 'sons under the hand it's difficult to imagine that general recession which does not generate losses on real estate loans so I think that's an example where there's going to be a clear cyclical element so if some country has imposed the systemic risk buffer even though the different theological reasons are structural there
it does the fact that provided some cyclical protection as well so if a country has a essentially is delivering cyclical protection to other types of buffers then the correct calibration of the sea cyb would be less so I think the holistic assessment of how much cyclical protections in the system no matter what the label on the buffer is I think it's quite important and as I say in advertising the work of the ESRB the structural buffer report earlier this year goes into a lot more detail and gives a lot more examples now if I turn to borrow based measures again these might be thought of as structural or steady-state measures but I think if you look at the history of how the distributions of loan to income ratios loan-to-value ratios that service to income ratios and so on move over the cycle it's clear I think that under 60 strong conditions there's a typically a reassessment built by banks and by households that essentially life is the future looks bright and what might be deemed a risky ratio as certainly is now deemed as okay so in the absence of ceilings in the absence of limits I did I think the distribution becomes more right-tailed for these ratios and so if we now have a system where more countries have these ceilings in place then the cyclical drift and these ratios may be less severe in the future and again if you believe you've limited the boom-bust cycle because of those fixed ratios then I think you're going to have a lower amplitude recycle and again a lower amplitude of a cycle by the way will feed into the calibration to see cyb let me finally just under cyclical issue you talk about fiscal policy because we in parallel typically when we are trying to advise how do we manage the risks associated with the cycle typically we advocate counter-cyclical fiscal policies whether that's simply just letting the automatic stabilizers work or even a possibly also having activists can't secure measures but if we have those in place then it again we might calculate the amplitude of the Bloomberg cycle is less and therefore the amount of protection we need from the market potential buffers is less conversely if those policies are not in place if fiscal policy is moving in a procyclical way then that may require a greater offset with macro-prudential policy so that's an interesting interaction to think about okay let me move to the second point I want to make which is about market-based finance and financial stability and again a couple of weeks ago we had the publication of the latest EU shadow banking monitor by the ESRB I think some of the numbers were cited by President Draghi earlier on but you know when you have as a universe which corresponds to about 40% of the EU total financial assets this is a large part of the European financial system and I think at the ESRB complete role here in terms of coordinating national efforts to track developments in market-based finance so I mentioned earlier on the ESRB is really a Coalition of the Willing across the different member states and especially when a lot of the regulation here is not a lot of the data collection is national here it requires good citizenship especially if I consider a lot of market-based finance to contribute now why should we care there's really two one is the scenario where the next crisis comes from Iran in the market-based sector so I run on investment funds where if they have illiquid assets and liquid liabilities we could have a problem and then second is the and whether it's independent or interacts or that basic factor is the banking system relies on the non banks they're about 8% of bank assets and are invested in these entities and they rely on this sector for about 2.2 trillion and funding so a problem in the non-bank financial sector quickly would spill over to the banking sector and we know what happens then so let me also point out that more and more we are also aware that is a link between the non-bank financial sector and the real economy so one thing we're noticing is the increasing importance of non banks as credit providers to non-financial corporates and to households as investors in commercial real estate and in residential real estate so there's you know if you're trying to understand the housing market now it's not enough to think about Bank provided credit the credit and the other types of funding coming from non-bank intermediaries is increasingly important in some countries so I think in turn what does what does that mean it means just as we absolutely insist we need to have a good understanding of the leverage the liquidity the maturity profiles of banks equally we need to have a corresponding information for non-bank intermediaries who are providing funding to the real economy progress here is I suppose that differentiated according to what slicer that you're looking at so present dragging earlier on I was highlighting that the progress we've made at ESRB and EU level visa v2 research data and the tsunami of daily data that's coming through there so of course at EU wide level it's it's really important to understand whether these as markets are being used to hedge risk to be risk reduction and risk transfer to those who can absorb it or be used active have synthetic leverage in an inappropriate way but in addition to that at national level especially countries with our international financial centers including my own jurisdiction it's very important to provide a deep and publish information on those sectors so let me mention a couple of a studies that we're doing at the central bank so in the shadow banking monitor there's a box which looks into the international linkages of Irish domiciled non securitisation special purpose entities so this is an area where we have a under legislation we can gather information we don't regulate these entities we can gather information on these entities and it proves to be a treasure trove of understanding how the international financial system works by and large these entities are irrelevant for the Irish economy but they are providing links from certain their countries of origin to certain destinations and I think it is a lot to be learned there so that box in the Indy monitor will give you that quite a bit information and then the second example from the monitor is this study of a credit of all these CDSs by usage funds so this is a joint work between it our central bank and start from a various EES or B member institutions so by the way in the bond to Frances at financial civility report this bring myself and that Katie Maloney the head of market-based finance at the bank we wrote an introduction or overview of this sector in the Irish economy and again we have no local financial stability reason to do so all of this is as a platform as a host for international activity but as an international public good at those countries with big sectors whether it's us or the other big financial sectors in Europe should be providing if we can so let me also and we think we've one of the strengths of the ESRB is it's links to the academic community to the scientific committee the ASE but more generally at the more the opportunities there are for researchers to help in the analysis of all the data we collect at the better so again at President Draghi already mentioned the bridge program for data science the joint ECB esre program and this really in terms of advertising to researchers out there provides a great opportunity which is I think a win-win provides a new data for academics but with a lot of direct policy relevance so let me conclude there that really the two points are making now is that I think the whole rationale of the ESRB was really to avoid delay what happened before which is inadequate use of macro-prudential policies during up swings we have an upswing now so let's use the instruments that have been made available to us and then second is the reality is so much of Finance has moved away from banks to non banks that we just have to move forward its move forward in terms of understanding through data analysis and then move forward with the agenda about working out what kind of policy instruments are appropriate for that sector as let me let me stop there and I kind of a I think I'll add some time for Q&A so I'm happy to take any comments or questions [Applause]
I don't who has the microphone front row Thank You field was really a very nice overview and when you started you said okay we we have this buffers so
we have resilient so in bad times we can use it to draw down a bit like with Egypt early after seven years of extra wheat and then you use it for the for the bad years could also play a role for slowing down the upswing yeah so that's an interesting point you might I mean I
think the safe way to phrase that is you might think so but the reality is that what's happening in some markets now is for example at credit might be restrictive but as I've just mentioned there are non-bank actors in certain markets so I think it'd be over promising to say not only are we providing I see the buffers for the next downturn but we're actually trying to affect the current dynamics I mean I think a lot of time it will have an effect but I think we're better off not relying upon that because in a market where there are some entities where they're under constraints other entities that are not you know I don't think it's it's a guarantee that you can necessarily influence current dynamics so we would not try and we would not claim we're trying to target the level of highest prices or targets other current indicators it's more to build the resilience for the downturn Daniel
banks presumably are more robust more resilient but but risks have been
migrating towards the non banking sector through shadow banking now macro-prudential policies also asked to deal with systemic risk in in shadow banking but apart from macro-prudential policy now there is a land of last resort function which in highly critical times should play a role in dealing with a banking crisis but what about non banks if non banks are huge and operators big lenders if something goes terribly wrong with the non but a huge don't bank or a CCP for example I mean who's going to perform the land of last resort function a central bank VCB again okay I think that's a very deep question
um and some of the issues that that's raised there is you know entities vs.
activities so clearly is it the case that you're looking with a bank you may want to save a bank because it you know it plays a certain role in the society what do you want to save an asset manager or as some other entity is a different question but I mean there's no - typically any central bank any monetary system in terms of the mechanics of having the stability of the currency and so on activity liquidity policies are expressed in a generic way it's not exclusively about whatever banks are on the list of counterparties today it's easy it's sort of much more broadly but equally inner may be a a way that's the kind of discretion is there to assess at a time what is appropriate as opposed to add to provide some kind of ex-ante guarantee that you can just show up and there receive liquidity let me emphasize also of course because it's important is not the case we think movie that the fact that the financial system that has a much bigger role for non banks is compared to counterfactual of just relying on banks having banks and non-banks has to provide more diversification if some of those non banks are long-only investors where did the people bearing that risk are well able to bear that risk that's fine we have this intermediate category where where we think about it which is where it's more Bank like where there's kind of short-run liabilities well the question is whether the investors think they're short from life safe liabilities or were they fully recognized these are really much more equity type investments so you know there's a lot of uncertainty there but it would be important to say it's not the case that this is a somehow making life worse it's just a new type of a system in terms of understanding what what are the financial stability implications of non-bank intermediaries and really the focus is on number one leveraged non-bank intermediaries and number two this issue where the the summoned and investors may perceive the libraries to be liquid when they're not
Richard portes London Business School and advisory scientific money but also
join us with Groupon shadow banking of the ESRB and it's in that role that I want to put my question I was pleased to hear you say what you said about and the president as well about the shadow banking monitor but we're now in the stage of preparing the force shadow banking market and as you you refer to two boxes in the current one in the light of the next crisis where is the next round its public et cetera what boxes would you suggest what topics would you suggest we might devote a special attention to four boxes in the next station thank you Richard I think Richard is
trying to catch me out on the spot I say I do have an immediate air thought about
us which is at the interconnection between non-bank intermediaries and property markets so I can tell you we we're definitely working on this topic about understanding when you have all of these new types of institution investors coming into commercial real estate and residential real estate understanding the balance sheets of those entities how much leverage do they have where's that that financing coming from so I think that could be an interesting at because let me because I just once these guys trying to say in the speech historically and even the phrase shadow banking sort of a connotes that you have to think about its relationship to the banking system but then if you want to think about the relationship to the real economy it's really true the banking system whereas when you have a serious amount of direct lending at going on so whether it's insurance companies providing mortgages other types of intermediaries being a players in property markets then that kind of a real channel is becoming increasingly important so I think you know I'm not a big fan of the phrase shadow banking at this point because the kind of topic of market-based finance and part of it is charter banking part of it is is other financial services you know I think there's no shortage of boxes for that I I'll give you one I gave you one okay the use of the CCB is
of course a fascinating issue because we know how it works in theory the question
is how will it work in practice if I remember correctly the Swiss National Bank applied a similar instrument some years ago and they somehow felt that it was just not powerful because the real estate market is so strong you suddenly have so strong inflows that this incremental increase was not strong my question is whether you have any observations on the experiences you have observed from other central banks and if it is not sufficiently effective what are the next steps then what's what's the plans or to say in general this goes back to what is the objective so if the
objective is I mean I think you can if you have a power based measure that limits the ability of hassles to take on debt I mean we do that it doesn't matter who's the credit provider whether it's a bank or non-bank so if you operate on the people in under households that can be effective in building hazard resilience if you could operate on the domestic banks even if other banks overseas so one historical thing in the mid-2000s were some countries had these measures and the domestic banks just lost market share to foreign banks under the hand that they may not have slowed down the credit boom but the allocation of losses was redirected so you can have a lot of game even if there's no impact on credit dynamics or house price dynamics and it's really the allocation of risk so it would be nice to be more powerful but even if you cannot deliver everything D still I think has some value which again goes back to what are you promising worried what is the objective what are you promising what can you deliver so I think the inability to control has prices does not mean you say nothing is possible either what you can
okay I think we did the fact that we are 15 minutes ahead of schedule reflects
President Draghi being 15 minutes ahead of schedule so I think we're on time so with that let me thank you for the questions [Applause]