By Alyce Andres-Frantz
CHICAGO (MNI) – Peter Praet, a member of the European Central
Bank’s Executive Board, Thursday said the fragile nature of the
financial system is two-fold due to a burdensome debt load and the
design of the central bank system.
In a keynote speech at the 14th Annual Internal Banking Conference,
organized by the Federal Reserve Bank of Chicago and the ECB, Praet said
although four years have passed since the onset of the financial crisis,
central banking functions remain “stretched to the limits.”
“Recent developments demonstrate how fragile our financial system
remains, not only because of debt legacy but more worrisome because of
its mere design,” Praet said.
“The public debt crisis in a number of advanced economies is also
raising fundamental questions about the role of public debt instruments
in our financial system,” he said.
In hindsight, Praet said “one can say that disciplining mechanisms
in debt markets have clearly failed, often as a result of mutually
reinforcing market and government failures. Too much debt in the public
sector is the symptom of both ineffective public governance and market
Furthermore, “Budget rules, such as the no-bail-out provision of
the Maastricht Treaty, didn’t contain the accumulation of debt. In the
banking sector, the disciplining role of sight-deposits has proven to be
time-inconsistent in the presence of the negative externalities that the
failure of a large institution would create. Although the role of
monetary policy in the build up of the crisis is still debated, it does
influence in an important way the price of leverage,” Praet said in the
Also striking was the “lack of attention and preparedness to
tail-events,” Praet said, adding that “too little efforts have been
devoted to the prevention of the conditions under which emergency
liquidity assistance would be provided to the financial sector.”
Praet said the development of separate macroprudential policy
functions is a needed policy reform whereby central banks should
assuming an important role.
Praet outlined the new EU financial supervisory architecture that
became operational at the beginning of 2011. He added that conducts
monetary policy also impacts on financial stability.
Praet added that some people desire vast changes in the ECB’s
institutional setup and their monetary policy strategies with a view to
pursue price stability and financial stability as coequal objectives.
“In my view, by contrast, major changes in the institutional and
strategic framework of monetary policy are not necessary. But business
as usual in central banking will not do it either.”
“The view has become more popular that under certain circumstances,
central banks may be well advised to actively lean against the emergence
of financial imbalances in order to mitigate systemic risk and the
associated longer term risks to price stability and economic welfare,”
“In order to achieve price and financial stability a pairing of
appropriate policies by all relevant authorities is indispensable. One
avenue might be to give an agent the specific mandate to assess the
financial stability impact of regulatory and tax changes when relevant,”
Policy coordination is no easy task, therefore a more rules-based
approach towards the macroprudential policy may better address the time
dimension of financial stability (like counter-cyclical capital
requirements or loan-to-value ratios) and tools relating to the
cross-section dimension (like surcharges for SIFIs, leverage ratios,
bank merger and acquisition policy, limits to business organization,
etc.), Praet said.
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