18 September 2013

Börsen-Zeitung interview with ECB/Cœuré and Bundesbank/Nagel

Former US Treasury secretary Henry Paulson has warned about a new financial crisis. The BIS has called it a "phenomenon reminiscent of the exuberance prior to the global financial crisis 2. Are we already sowing the seeds of the next financial collapse?

Nagel: A long period of low interest rates increases the risk that market participants will "search for yield". Overexuberance in the markets could pose risks to financial stability. As central banks we have to monitor that very closely. This is all the more true because we now have a major share of responsibility for macroprudential supervision. At the moment, I see a low risk of a crash of the kind you have described.

Cœuré: In this moment I would be less worried than the BIS is. But I’m talking about the here and now, not about the future. In the future we have to be very cautious. We know that there is a risk of asset price bubbles if there is a lot of liquidity. But you also have to keep in mind that the whole regulatory framework has changed radically. Before 2007 banks and other financial actors have borrowed to invest in risky assets. Now the ability for banks to do so is much more limited.

But there are other segments with less or even no regulation – for example the shadow banking sector.

Nagel: If one sector is heavily regulated and another less strictly, this may provide an incentive to sidestep the regulated part. Credit intermediation outside of the sphere covered by banking regulation could give rise to systemic risk. We need to identify this risk and take action if required.

Besides forward guidance, markets have been talking a lot about OMT and the upcoming decision of the German constitutional court. What would be the implications if Karlsruhe imposes tight constraints on OMT?

Nagel: It is not helpful to speculate about the upcoming decision of the court. We expect to see a legally balanced outcome to the pending case. The Bundesbank has expressed its criticism of OMT and stands by its reservations. The conduct of OMTs involves risks of which we must be aware at all times.

Cœuré: I also do not want to speculate. We at the Executive Board of the ECB think that the potential risks of the OMT – also those raised by the Bundesbank – have been identified and mitigated through the design of the programme. OMT has helped us eliminate the risk of an unintended euro exit, which could have had catastrophic consequences and would have threatened price stability. The subsequent improvement on financial markets also reduced the reliance of banks on ECB liquidity, and as a consequence it reduced the risks to the ECB’s balance sheet. One can speculate about the potential risks related to OMT, but the existence of OMT has – as a fact – reduced risks borne by the ECB and its shareholders. Anyway, from the legal point of view the decisions of Bundesverfassungsgericht would not be binding on the ECB, which is a European institution.

This would only be the case with a decision of the Court of Justice of the European Union. But Karlsruhe could impose de facto limits on OMT – through the ESM and the Bundestag.

Cœuré: I really don’t want to speculate on such ideas, this is an unchartered territory.

Klass Knot of the Dutch central bank has said that OMT could last at least for 10 years because it would take at least a decade for euro area countries to reduce their debt ratios substantially.

Cœuré: OMT is a very narrow instrument targeted at a very specific type of risk, which we call the redenomination risk. Meaning: the risk of markets wrongly expecting countries to leave the euro area. There is only a low probability that OMT will be used, but it will stay with us. I also don’t see any reason for changing the conditionality. It is as it is. Now it’s for the countries to decide whether they want to apply or not.

Ireland will ask for a precautionary credit line from the ESM to safeguard the return to the capital markets. Would it be possible for the ECB to activate OMT and buy bonds before such a credit line is drawn?

Cœuré: Once the Eurogroup has agreed on an appropriate programme, the ECB’s Governing Council can activate OMT. The credit line doesn’t have to be drawn. But the Governing Council will make this decision in full independence.

Full interview

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