BERLIN (MNI) – ECB Executive Board member Peter Praet on Friday
defended the central bank’s new bond-purchasing program, OMT, stressing
that it tackles unfounded fears about the reversibility of the euro.

In a draft for a speech to be delivered at a conference in Milan,
Praet noted that the ECB had drawn up the OMT “in order to address
severe distortions in government bond markets which in particular
originate in unfounded fears on the part of investors of the
reversibility of the euro.”

Moreover, the “OMT also aims to safeguard the monetary policy
transmission mechanism in all countries of the euro area, thereby
preserving the singleness of the ECB’s monetary policy,” the ECB chief
economist said.

However, “while monetary policy can alleviate deleveraging
pressures in crisis times, it cannot address their root causes,” Praet
cautioned.

“It is of the utmost importance that national governments and
European policy-makers undertake all needed structural measures to
address the fundamental sources of the current crisis,” he stressed.

“In fact, to tackle the underlying problems, a wide-ranging policy
response is necessary, inter alia, pertaining to public finances,
economic competitiveness and the financial sector,” Praet insisted.

The European banking sector is currently experiencing a “necessary
correction to overcome past excesses and to restore its health,” he
explained.

While the deleveraging of the banking sector is necessary to
correct the imbalances built up prior to the crisis, disorderly
deleveraging can represent a “serious threat to price stability,” Praet
warned.

The transmission to the real economy of shocks hitting financial
institutions’ balance sheets “is exceptionally strong if banks are not
able to shield credit supply and if borrowers are highly dependent on
bank credit to finance investment and consumption,” he pointed out.

Many banks in the Eurozone have been highly dependent on market
funding and have therefore been vulnerable to sudden stops, he noted.

Moreover, banks are the main providers of funds to the
non-financial sector in the Eurozone. “Therefore, the potential for a
very large amplification of shocks to the real economy is particularly
strong in the euro area,” Praet said.

The ECB’s non-standard measures have prevented “destructive
self-sustained dynamics,” he reckoned. “They have also helped to address
heterogeneity in the transmission mechanism of monetary policy across
different euro area countries. And most importantly they have
contributed to ensuring price stability.”

Yet, the Executive Board member conceded that there are risks from
the ECB’s unconventional measures.

“First, there is a risk of distorting the incentives to carry out
the necessary adjustment by favouring evergreening of loans and
‘zombie-bank’-type dynamics. This would represent a continued source of
uncertainty about banks’ exposures to non-performing loans, about the
possible implicit liabilities faced by governments and ultimately a drag
to economic growth.”

Moreover, large liquidity-providing repo operations increase asset
encumbrance in the banking sector, he noted. “Banks tie up certain types
of collateral with the central bank, and these assets are no longer
available to the bank for other types of transactions,” he elaborated.
This increases banks’ difficulties to issue unsecured bonds and can
potentially worsen their access to private sources of refinancing.

Now, a more integrated financial market union “is one of the top
priorities” in Europe, the central banker argued. The first step is the
establishment of the planned single banking supervisory mechanism.

“As a further key element, the European Commission recently
released a proposal for a bank recovery and resolution directive, which
contains important crisis prevention, early intervention, and resolution
tools,” Praet said.

–Berlin bureau: +49-30-22 62 05 80; email: twidder@marketnews.com

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