FRANKFURT (MNI) – The following is the first part of verbatim text
of European Systemic Risk Board Chair Mario Draghi’s introductory
statement given before the Committee on Economic and Monetary Affairs of
the European Parliament:

Introductory statement by Mario Draghi, Chair of the ESRB Brussels,
9 October 2012

Dear Madam Chair,

Dear Honourable Members,

I am very pleased to appear before this Committee today to inform
you about the activities of the European Systemic Risk Board (ESRB).

As you know, the ESRB complements the know-how of central banks,
national supervisors and the three European Supervisory Authorities by
delivering what has come to be called a macro-prudential perspective.
What this means is the capacity to analyse risks across market segments,
to address vulnerabilities which currently lie mainly in the banking
sector and to examine medium-term risks in the financial system as a
whole.

Based on such analysis, combined with proposals for remedial action
by way of warnings or recommendations, the ESRB will help to protect
Europes economy from fragility in the financial system.

An important step in the ESRBs work was the publication of the
first risk dashboard on 20 September 2012. The dashboard was requested
by this Parliament in the legislative process establishing the ESRB. It
consists of a set of quantitative and qualitative indicators aimed at
identifying and measuring systemic risk.

The risk dashboard has been produced in cooperation with the
European Central Bank (ECB) and the three European Supervisory
Authorities (ESAs). It is one of the inputs considered by the ESRBs
General Board in its discussions of risks and vulnerabilities in the
financial system.

The dashboard, which will be updated quarterly, looks at six
different categories of risks, sectorally and across the financial
landscape. It should be considered an information tool that orients
further analysis on systemic risk, rather than a fully-fledged early
warning system.

The General Board has decided to publish the dashboard and its
underlying data on the ESRBs website. Risks in the banking sector

Let me turn to the current situation. The European economy and
financial system continue to face challenging times and it is vital
always to be mindful of systemic risks. But there are also reasons to be
confident, provided that policy-makers continue to implement agreed
measures with determination.

These measures include macroeconomic and structural reforms to
ensure competitiveness and sustainable public finances. They include
continued financial reform to ensure a resilient and well-functioning
financial system. And they include further development of Europes
institutional framework.

From a macro-prudential perspective, there are three main possible
risks. First, the risk of setbacks in the implementation of agreed
measures. Second, the risk of downside macroeconomic news with
implications for banks asset quality, profitability and funding. And
third, the risk that feedback loops between these two factors may affect
the supply of credit, which in turn will affect the real economy.

Revitalising the supply of credit is crucial for the recovery.
Notwithstanding some reductions in market tensions, financial activity
remains impaired in various parts of the system. At this time, the role
of macro-prudential policy is primarily to restore trust in the
financial sector.

To rebuild investors confidence in banks, it is necessary to
reassure them about asset quality. There are a number of options that
authorities can consider. One is enhanced disclosure, for example, on
the level of provisioning. A second option is supervisory assessments of
asset quality, possibly including peer reviews by supervisors and third
party assessments and a third option, where necessary, is the setting up
of separate entities to deal with low quality assets.

Important work is already being done by the European Banking
Authority (EBA), assessing forbearance in the banking sector, promoting
coordinated reviews of asset quality and harmonising definitions of key
variables such as non-performing loans.

The ESRB plans to make further proposals for macro-prudential
policy, particularly on vulnerabilities linked to bank funding. In light
of the impairment of some credit and interbank markets, the ESRB,
together with the EBA, is reviewing asset encumbrance and complex
funding instruments such as synthetic exchange-traded funds and
liquidity swaps. The aim is to identify sources of systemic risk and
policy actions to mitigate them. I intend to present the results of this
process at the next hearing in the first half of 2013. Risks in
financial markets

The ESRBs examination of the financial system extends well beyond
the banking sector. Today, I would like to focus in particular on
developments in the field of central counterparties (CCPs) and
over-the-counter (OTC) markets. I will outline the analytical work done
by the ESRB and the policy advice it has given.

The implementation of the G20 commitment to central clearing for
all standardised OTC derivatives has important consequences for the EU
financial system. The ESRB started to assess the systemic implications
of the more prominent role for CCPs that they will become a crucial node
within the financial system.

Macro-prudential examination of CCPs relates, in particular, to the
pro-cyclicality of margining and haircutting practices. Such practices
have an important bearing on financial conditions in the economy. While
the more prominent role for CCPs reduces counterparty risk, it
inevitably implies an increase in concentration risk. Therefore, the
ESRB issued advice to the European Securities and Markets Authority
(ESMA) on two aspects regarding the systemic resilience of CCPs.

On collateral, the ESRB advised the ESMA to increase the systemic
resilience of CCPs by better defining the type of eligible collateral
and the conditions under which commercial bank guarantees may be
accepted as collateral by CCPs. The ESRB also advised that risks related
to cross-collateralisation should be adequately taken into account.

On clearing among non-financial corporations operating in
derivative markets, the ESRB advised the ESMA to restrict the
possibilities for such corporations to settle outside CCPs, so as to
reduce counterparty risk. Regrettably from a macro-prudential viewpoint,
there is a risk that the systemic vulnerabilities identified by the ESRB
will remain at least partly unaddressed. This is due to an
interpretation of the EMIR legislation that has made it difficult to
translate fully the ESRBs advice into technical standards.

On OTC markets more broadly, the ESRB is examining potential risks
stemming from market practices that have become very common in the
so-called shadow banking sector. For example, collateral pledged by a
client may be re-used by a lender for own borrowing needs.

This pattern, which is called re-hypothecation, may be repeated
several times for the same collateral. It can therefore create a
contagion chain in case any party fails to deliver. In other cases, when
collateral for securities lending transactions is represented by cash,
that cash may re-invested by the lender. In case such re-investment
takes place in a risky asset or for a longer maturity, there are risks
of so-called reuse of cash collateral in securities financing
transactions.

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