14 September 2012

Bundesbank/Dombret: The role of the state in the financial system

In his speech at the ifo/CESifo/Bundesbank Conference, Dombret said: "The crisis has shown that, like it or not, the state is needed as the ultimate guarantor of systemically important functions of the banking sector".

In a systemic crisis, deposit insurance schemes can succeed only if the state, and thus the taxpayer, credibly guarantees the liabilities, as illustrated, for example, by the TV appearance by Chancellor Merkel and Finance Minister Steinbrück in 2008, in which they guaranteed all banking deposits in Germany.

Another example is the international discussion on large banks. Due to their systemic importance and interconnectedness, no state can afford to let them descend into disorderly default. Therefore, resolution regimes are currently being discussed by international fora, so that, in principle, also large banks can exit the market without causing systemic disruptions. In this respect, i.e. by establishing a clear framework to limit financial stability risks, I believe the state has its role. This is exactly where regulation comes in: An appropriate, internationally harmonised regulation as well as resolution schemes endeavour to ensure that “too-big-to-fail” banks do not abuse their status.

There are some parallels between these considerations and the challenges of the debt crisis. Nowadays, views such as: “Markets help to discipline fiscal policies, which is what we urgently need to resolve the crisis” do not seem to be very popular. However, popular or not, what matters is whether or not this statement is true. It may well not be true all the time. However, to me there seems to be more truth in this view than in many so-called “solutions” implying ever-increasing unconditional financial “assistance”. Many of these proposals ignore moral hazard implications and might therefore simply postpone solutions. They might even increase the problems they are meant to tackle in the long run.

Financial assistance is necessary to buy time – nothing more and nothing less. It cannot be a long-term solution. Such a long-term solution can only be achieved through fiscal consolidation and structural reforms.

As with banks, we cannot ignore or deny the systemic importance of certain countries within the euro area. And in the same manner, it is vital to ensure that politicians cannot use this status to delay necessary steps simply because these steps are unpopular.

To reach an appropriate assessment, it is also essential to know whether we are currently still in a situation in which markets can successfully exercise their disciplinary powers – or whether we already have moved to a full-blown systemic crisis in which the threat of self-fulfilling downward spirals calls for massive intervention.

But even if this were the case – and let me make this very clear – it would be up to democratically elected governments, and not up to central banks, to take the necessary action. Central banks can give advice – but only governments have the authority, conferred by their democratic legitimacy, to make changes to regulatory systems.

Full speech

© Deutsche Bundesbank