25 March 2014

ECB/Draghi: A consistent strategy for a sustained recovery

Cleaning up the banking sector

The euro area banking system is now undergoing a process of restructuring and deleveraging. As this is a necessary correction, it is not a process that policymakers should seek to prevent. However, it is a process that needs to be properly managed...

The SSM provided a catalyst for the clean-up of the banking system to take place more quickly and more comprehensively than would otherwise have been the case... In fact, the cleaning-up of bank balance sheets does not need to wait for the end of this assessment. The best outcome is one where banks are forward-looking and take any corrective action before the end of the process. And indeed, we have seen in many cases that banks have revised asset valuations, raised equity and disposed of assets...

Over time, I expect this process, together with the new regulatory framework which is now being completed by the Basel Committee, to result in a euro area banking system with a more streamlined balance sheet structure and higher levels of capital. We should be wary of situations where bank assets are many multiples of GDP, as we saw in countries like Ireland and Cyprus before the crisis. Bail-in ability will likely also mean that senior unsecured bank debt plays a lesser role in the future relative to deposits. In other words, this will be a banking system that comes closer to its traditional role of taking deposits and making loans. However, a permanent shrinking of the banking system raises some questions about how finance will be intermediated in the euro area. If intermediation between savings and investment is taking place less through banks, then it must take place elsewhere, through capital markets...

If we are to continue with a consistent set of steps to support the recovery, cleaning up the banking system therefore has to be accompanied by policies to facilitate the development of capital markets, especially for smaller firms. It is for this reason that we have frequently highlighted the importance of creating conditions that support capital market deepening, including by removing regulatory obstacles to the least risky models of securitisation.

Moving towards a sustained recovery

This “rebooting” of the financial system, together with the construction of the Banking Union, had to be the first step in a consistent strategy, as a healthy banking system is a necessity for a sustained recovery. Yet it is still only an enabling factor. What it achieves, essentially, is to create an environment where “normal” macroeconomic management can resume. It is this that generates the recovery.

The banking sector supports this process through two channels. First, it facilitates the ability of monetary policy to maintain price stability and help economic growth return to its potential. Second, it ensures an adequate supply of financing for investment, and an efficient allocation of credit between productive and non-productive firms, thus also supporting potential growth.

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Completing the picture

The rebooting of the financial system is necessary but not sufficient to achieve higher investment. Investment is also low because demand is low and there is slack in the economy. This will partially unwind as the economy recovers, but we cannot exclude that investment will not return to its former level as certain sectors have permanently downsized as a result of the crisis. This raises the question of whether policy is doing enough to compensate for these structural changes – in particular, whether it is creating the framework conditions for new business models to emerge that require higher levels of productive investment...

What is different today, compared with a decade ago, is that weak productivity can no longer be hidden by increasing private leverage or rising public sector debt. There are no levers that can be pulled to raise real growth other than those that address the structural barriers in our economies. Fiscal policy can support growth by ensuring that consolidation has a better composition – less focused on raising taxes, more on prioritising expenditure – but it makes no sense to unwind consolidation now that the hard work has been done. This is why I reiterate that there is no bigger policy challenge for the euro area than raising potential growth.

Conclusion

The point I have tried to emphasise today is simple: to navigate through a debt crisis such as the euro area has experienced, the sequencing and above all the consistency of policy choices is everything. We need to be consistent across space, and we need to be consistent across time. There are indeed two inescapable lessons from the account of events that I have presented to you today.

First, a full recovery will be achieved when – and only when – we complete in full the sequence of steps I have highlighted. With each step in this sequence, we should not ask “Have we done enough?”. It will be clear when we have done enough: when debts are reduced, when potential output has been raised and when unemployment has come down – while all along preserving the integrity of money, meaning price stability. This means, ultimately, looking hard at whether our economies are fit for purpose in a specialised, globalised knowledge economy. This is something that national governments, businesses and social partners have to do together. What is being done here in France is important in this respect, as a strong euro area needs a strong French economy.

The second lesson is that the recovery stems from joint action. We have seen the effects of the fragmentation of financial markets across national lines. We have experienced the consequences of confidence diverging across countries. We have suffered from the resulting loss of growth and rise in unemployment. No one who has experienced either this crisis, or the economic volatility of the 1970s and early 1980s, can credibly conclude that a return to a mere juxtaposition of national policies will improve the situation of any of our countries. Rather, it is by making our policies consistent across borders that we have achieved positive results, and it is by heeding this lesson that we will continue to do so. In some areas, such as the banking union, this means formulating policy centrally. In other areas, such as fiscal policy or structural reform, it means accepting effective scrutiny from peers. In both cases, this is not a loss of sovereignty. In fact, I regard it as a recovery of sovereignty, because it is the means to provide once again, and sustainably, the stability and the opportunities that citizens demand from policymakers.

Full speech

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