ECB Paramo: Danger Central Bank Aid Makes Banks Dependent

FRANKFURT (MNI) – There is a danger that the support extended to
the financial system by central banks in times of stress could turn into
a “lasting dependence” on central bank financing, European Central Bank
Executive Board member Jose Manuel Gonzalez-Paramo warned on Friday.

The creation of central bank money may also pose inflation risks if
the funds are not withdrawn in a timely manner, Gonzalez-Paramo argued
in the text of prepared remarks for a conference in Cyprus.

Addressing the balance between financial stability and price
stability within the ECB’s purview, Paramo insisted it is “vital that
the primary nature of the ECB’s price stability mandate is preserved,
even as it assumes greater responsibilities in the macroprudential and
financial stability spheres.”

“Central bank independence in the pursuit of its price stability
mandate must be preserved, notwithstanding the assumption of greater
responsibilities for financial stability,” Paramo said.

Speaking about possible political pressures that could emerge when
a macroprudential supervisor recommends restrictions on credit growth or
leverage based on a geographical or sectoral basis, Paramo emphasized
that “conduct of monetary policy in pursuit of price stability must be
insulated from such pressures.”

“I would therefore emphasise that central banks make their best
contribution to supporting financial stability by continuing to credibly
deliver price stability,” he said. “Over the medium term, price
stability and financial stability are always complements.”

“Even in the short run, we should not entertain trade-offs between
price stability and financial stability: via expectational channels, any
compromise in the pursuit of price stability would endanger its
achievement and, by implication, threaten financial stability which
rests upon it.”

Experience shows that the Eurosystem’s operational framework offers
automatic stabilizers within the context of crisis management, Paramo
said, “in part by allowing an elastic intermediation role to the central
bank.”

And, “these have proved to be very helpful features in dealing with
recent challenges.”

Looking ahead, central banks’ operational frameworks should
maintain or introduce such features, allowing for differentiation
according to currency areas or financial markets/banking systems.
“Nonetheless, I believe that the ECB’s framework provides a valuable
blueprint,” he stressed.

“However, the danger exists that the support offered to the
financial system at a time of stress morphs into a lasting dependence of
banks on central bank financing, blunting incentives for necessary
structural change in the financial sector,” he warned.

“Such support may also increase the direct financial and balance
sheet risks of the central bank itself,” he elaborated. “And ultimately
the creation of central bank money may pose inflationary risks, if it is
not withdrawn in a timely and effective manner once broader economic
conditions normalise.”

–Frankfurt bureau; +49-69-720142; frankfurt@marketnews.com

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