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Speech by Mr Klaas Knot, President of the Netherlands Bank, at the European Investment Bank's Annual Economics Conference "Investment and Investment Finance", Luxembourg, 23 November 2017. | “Investment and investment finance in Europe” Speech by Klaas Knot at the EIB’s Annual Economics Conference: ‘Investment and Investment Finance’, Luxembourg, 23 November 2017 Investment is a key driver of future economic growth, and is therefore vital to the continuing expansion of the European economy. Important challenges like investment in human capital and climate change call for substantial private and public investment. I would like to start by thanking the organizers for inviting me to speak at this year’s Annual Economics Conference. I’m also glad I have the opportunity to discuss such an important subject with you. After all, investment is a key driver of future economic growth, and is therefore vital to the continuing recovery of the European economy. Today, I’ll share my thoughts as a central banker on investment in the euro area. I’ll do so by addressing three main questions: First, is euro area investment currently too low? Secondly, I’ll focus on business investment, and examine what its drivers are. Lastly I’ll give my view on how public investment can be tailored to contribute to sustainable economic growth. Question1: is euro area investment too low? Let’s start with the first question: Is euro area investment too low? Looking at Figure 1, we see the development of real investment and its components in the euro area. The yellow line represents the level of real total investment. As you can see, total investment started to recover in early 2013. This was after a period of substantial contraction during the financial crisis and its aftermath. However, it has not yet recovered to pre-crisis levels, despite the unprecedentedly favorable financing conditions. figure 1: Business, residential and public investment in the euro area 2008Q1=100 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Public investment Housing investment Source: ECB Does that mean euro area real investment is too low? That depends on the type of investment we consider. It also depends on the benchmark used for comparison. I’ll elaborate both these points. Firstly, total investment growth masks the heterogeneous development of its individual components. These have different implications for the future growth potential of an economy. Figure 1 shows that although total investment is still clearly below pre-crisis levels, this is not true for non-residential private investment, which I’ll simply call business investment. As shown by the dark blue line, real business investment in the euro area has recently approached pre-crisis levels, exceeding both public and residential investment. The latter only started to recover in late 2014 and currently stands at around 20% below its pre-crisis peak. Public investment seems to have stabilized at a somewhat lower level with respect to pre-crisis years, after having declined by over 20% between 2009 and 2016. The distinction between various investment components is important. It is primarily business investment and public investment that is relevant for the long-run productive capacity of an economy. So I’ll leave residential investment for the time being, and just focus on business investment and public investment. Secondly, the diagnosis of whether investment has been low, also depends on the benchmark used. Usual benchmarks include comparisons with past investment growth rates, pre-crisis investment levels, or developments of other macroeconomic variables such as GDP. Figure 2: Business investment ratio in the euro area Ratio to GDP; investment and GDP are both in real terms 14,0 13,5 13,0 12,5 12,0 11,5 11,0 Total investment, Real (lhs) Private-sector non-residential Investment, Real (rhs) average (2003Q1-2017Q2) Source: ECB Although it is not a priori clear which benchmark to use, in Figure 2 we compare the development of business investment to that of GDP. The dark blue line on the right-hand-side shows the ratio of euro area real business investment to real GDP. This has now surpassed the average observed since the early 2000s, represented by the grey line. However, it is still clearly below its pre-crisis peak. The recovery of the real total investment to real GDP ratio, shown by the yellow line on the left-hand-side, has clearly been more protracted. When discussing the dynamics of investment, we also have to consider the measurement issues around investment. The structure of the euro area economy has been shifting towards the services sector. Consequently, the nature of investment has been changing, with a notable increase in expenditure on intangibles such as design, patents, branding, and employee-training. This has implications for measuring investment, as intangible assets are only partially included in the official statistics. For example, in last year’s winter forecast report, the European Commission showed that the inclusion of intangibles not currently classified as investment, would more than double the share of intangible investment in business sector gross value added. So what’s the diagnosis based on this data? Is the glass half full or half empty? Figures 1 and 2 suggest the glass is half full, as business investment has been recovering and reached pre-crisis levels. But we should also be wary of signals that suggest the glass might be half empty. Given the ample cash holdings of non-financial corporations, and very favorable financing conditions, one would expect investment growth to have accelerated even further. To understand why investment growth has thus been weaker, I’ll turn to the second question. Question 2: What has been driving the observed developments in euro area business investment (or why is investment growth not accelerating?) Before we look at the empirical evidence, I’d like to briefly discuss the two hypotheses that have gained currency: the secular stagnation hypothesis and the financial cycle hypothesis. According to the secular stagnation hypothesis posited by Summers, the global economy faces a structural aggregate demand deficiency. And this is also likely to persist in the future. Investment is not therefore accelerating because demand is structurally low. According to the financial cycle hypothesis, maintained by the Bank of International Settlements, the global economy is currently struggling with the adverse consequences of a financial slump. Investment recovery has been suppressed because households, firms and governments have been deleveraging. The two hypotheses differ based on the length of the decline in investment. Whereas the financial cycle hypothesis argues that investment is temporarily low, the secular stagnation hypothesis predicts permanently low investment. Despite their differences, both hypotheses have a common denominator: demand. In particular, uncertain future global demand is seen as a key factor weighing on business investment growth. Figure 3: Historical shock decomposition of real business investment growth Percentage points -5 -10 -15 Foreign demand Real lending rate Real gross operating surplus Real stock prices -20 Uncertainty* Real consumption Real business investment *Average over various uncertainty indices (consensus, policy, macro, financial, Jurado et al.) Source: DNB Let’s look at Figure 3. It shows a historical shock decomposition for the Netherlands based on a Vector Auto Regression analysis, or VAR. We can see that business investment growth was largely driven by uncertainty shocks and foreign demand shocks, represented by the red and the blue bars, respectively. Uncertainty is measured here as an average of various uncertainty indices. It has had a positive impact on business investment since 2013. Foreign demand has had a negative impact on real business investment over that same period. These results therefore suggest foreign demand is the main factor still weighing on investment growth. However, this probably doesn’t reveal the whole picture. That’s because macro-data hide important heterogeneity across firms. I’d like to illustrate this by referring to a recent DNB study, based on Dutch firm-level data. The study offers two important insights. First, firm leverage is a key determinant of business investment; highly-leveraged businesses invest less, which is particularly true in the period after the financial crisis. This suggests, in line with the financial cycle hypothesis, that balance sheet constraints matter. This could partly be because external lenders have become more risk averse, and have started paying closer attention to balance sheet health when providing credit. Second, it appears that SMEs in particular have become more financially constrained, and have reduced investment since the crisis. The ratio of investment over fixed assets of large Dutch firms was eight percentage points higher than that of SMEs after the financial crisis. Cummulative share of banks changing acceptance criteria (%) Figure 4: Cumulative changes in credit standards (by MFIs in NL) Data normalized (2003 = 0) tightening easing -200 -400 Cumulative changes in credit standards SMEs Cumulative changes credit standards large firms Source: BLS, own calculations Figure 4 shows how credit standards already started to ease in 2010 for large firms in the Netherlands, while they continued to tighten for SMEs until 2014 and remained tight thereafter. A 2017 study by Gopinath and others reveals that reallocating funds towards large firms may have unintended consequences. The study shows that large firms attract more funding because they have higher net worth, but are not necessarily more productive. Based on data from Spain, this study explains a significant fraction of the observed decline in total factor productivity, relative to its efficient level in the run up to the crisis. So, while I can’t really offer any definite answer to the question of why investment growth has been subdued, the evidence we’ve seen points at two issues in my opinion: foreign demand and weak balance sheets. While weak balance sheets underline the financial cycle view, it’s still unclear why foreign demand is low. It would be interesting to hear your thoughts on this during the panel discussion. Question 3: contribution of public investment? The last question I want to address is how public investment can contribute to sustainable growth. The decline in public investment and current low interest rate environment, have prompted calls to increase public investment as a way to raise potential output. In my view, public investment should be considered when there is a positive social cost-benefit analysis and when private actors fail to achieve desired outcomes. Furthermore, public debt levels are still high in the aftermath of the sovereign debt crisis. The first priority of governments should therefore be to build buffers. A more growth-friendly mix of government expenditures will thus be even more important for countries currently in this situation. Having said that, I would like to discuss two areas I think meet the criteria for government action: human capital accumulation and mitigating climate change. To begin with, investment in human capital is essential for future growth. As unfavorable demographic trends will have a negative impact on the growth of labor supply, future growth will be more dependent on productivity. Research shows that human capital is a key driver for productivity growth. Public investment is required, because of credit restrictions, which for example prevent access to education for disadvantaged groups, and externalities associated with investment in human capital. Moreover, according to the EIB report, firms are already citing the shortage of skilled labor as a pressing problem. Accordingly, surveyed firms cite professional training and higher education as their first priority for public investment, underlining once more the need for policy action. Figure 5: Radical transition towards a CO2-neutral economy is necessary CO2-emissions Gt CO2 per annum No policies Current policies 2 degrees scenario Source: PBL & ECN Secondly, investment in climate change mitigation technologies is necessary to meet the Paris climate goals. Figure 5 illustrates how limiting global warming to a maximum of 2 degrees requires a substantial reduction in global carbon emissions. In this light, the evidence from the EIB report that investment in climate change mitigation in the EU has actually declined since 2012, is concerning. Public investment will, for instance, be needed in basic research and development. It is likely that markets underinvest in basic research due to positive externalities, which mean that private actors do not capture the full gains. Meeting the Paris climate goals will also require substantial private investment. Governments should therefore not only make investments themselves, but also pave the way for necessary conditions for private investment. An important step would be to introduce more adequate carbon pricing. This would provide better financial incentives for sustainable private investments. This also calls for pursuing a credible path towards a carbon-neutral economy that allows private actors to gradually adjust their investments. And finally, providing necessary conditions also includes ensuring financial regulation does not lead to unwanted side-effects. The FSB is currently looking into whether financial regulations are hampering private sustainable investments. Conclusion Ladies and gentlemen, allow me to conclude. There are important challenges ahead, which I believe call for substantial private and public investment. I’ve mentioned human capital and climate change, but there are certainly more. I would be curious to hear your views. So I look forward to fruitful and constructive discussions today. I trust the knowledge we share will help improve our understanding of recent investment dynamics in Europe. And that it will help shape our response to these challenges we face. | netherlands bank | 2,017 | 11 |
Lecture by Mr Frank Elderson, Executive Director of the Netherlands Bank, at the UNEP Finance Initiative (FI) Positive Impact Finance, Amsterdam, 23 November 2017. | “From 1 to 17?” Lecture Frank Elderson at UNEP Finance Initiative (FI) Positive Impact Finance Amsterdam, 23 November 2017 If you would take a closer look at all the things done, perhaps we can be a bit more critical. So far, most of our climate-risk related work is focused on climate-related risks. We’ve looked at how the energy transition could impact the economy, we’ve looked at how the financial sector is at risk from climate change and the energy transition. But being critical, from our supervisory mandate we’re mostly just focusing on climate risks. But isn’t climate just one of the SDGs? Aren’t there 16 other SDGs? And couldn’t each of these SDGs have physical or transition risks for our economy and therefore for our financial sector? The Principles and the Manifesto pose serious questions for serious times. Questions that we also ask ourselves and that we struggle to answer. ---- Good afternoon everyone, and welcome to DNB. It’s a pleasure for us to host UNEP Finance Initiative (FI) today and its work on Positive Impact Finance. As many of you know, DNB has been quite active on the topic of sustainable finance. Hosting a third party event however is not something we very often do. The main reason is that Positive Impact Finance is unambiguously ambitious and we recognize some of that trait in our own character. Challenges… Our societies are facing tremendous challenges, and are facing a lot of them at the same time. In terms of our climate; our world is now already more than one degree warmer than it was before the industrial era. For one thing, this has caused the amount and the severity of storms and floods to increase, worldwide often with deadly result, as we have seen far too often this year. But climate is just one challenge: Nearly 2 billion people worldwide do not have access to clean drinking water. 700 million people are living under the poverty line of almost 2 dollars a day. And in Sub-Saharan Africa, four in five people are undernourished and 45% of children die before they are 5 years old because of malnutrition. The good news is that we have international agreements targeting these issues. We have the Sustainable Development Goals and the Paris Agreements. Wouldn’t it be wonderful if just like a multinational, the world would have a clear strategy? Well, not only does the world have such a strategy, we, increasingly, see many governments, business and investors taking steps to pursue it and to tackle these challenges. But we also need to be realistic: we are a long way from achieving the goals. Let’s take a look at China for example. Sure, it’s the green energy and green finance power house of today. It’s the world’s leading producer of solar and wind power, and it’s the largest green bond market in the world. But it also uses and produces 50% of all the coal burnt globally. It’s responsible for 25% percent of all daily energy consumption. And CO2 emissions are rising worldwide again, mostly because of China. So the challenges remain. Funding the transition And what’s more all of these challenges have a financing element. For climate for example, it is estimated that an additional 1.5 trillion dollars are needed annually to finance the required investments. And for all of the SDGs combined, an estimated 5-7 trillion dollars are needed annually until 2030. As the UNEP FI Manifesto rightly states, all of the current initiatives together, however impressive, will most likely not be enough to finance the SDG investment gap. And so, what is needed, according to the Manifesto, is a financial sector that jointly considers the three pillars of sustainable development: economic, environmental and social. And that any investment should deliver a positive contribution to one of these pillars, once any potential negative impacts to the other pillars have been identified and mitigated. Eric Usher – and we are very proud to welcome him here on our premises - will explain the thinking behind UNEP FI’s conclusion that in their assessment a transition to a new finance paradigm is required. That’s right, ladies and gentleman, a new paradigm no less! Talking about ambition… Getting to a financial sector that bases itself on an appraisal of both positive and negative impacts will not be easy, I’m afraid. In fact, it´ll be hard. And if it were to be done, it would require courage, practice and perseverance. And there will probably be moments where you might simply think: this is in fact impossible; there is simply no way to achieve this, so why am I even hurting my brain over this? Dutch initiatives Well, should that be the case, please allow me to share two considerations with you that might make your struggle more bearable. One: I’d dare to say, somewhat chauvinistically, that The Netherlands is among the frontrunners in the world in terms of incorporating sustainability considerations in finance. Many of our financial institutions assess ESG factors in their investment decisions. Based on a survey we recently conducted, 17 out 28 surveyed financial institutions measure the carbon footprint of at least a part of their balance sheet. And 9 of those have even committed to lowering that carbon footprint. Furthermore, our banks have collectively issued a climate statement, an SDG-dialogue document, and an international covenant on human rights in project finance. They are key players in the Equator Principles, in carbon disclosure and divestment initiatives. Many of our insurers and pension funds, bring up ESG-issues in investor calls, and have ESG-engagement strategies. And three out of the top 10 of most sustainable companies worldwide according to the Canadian Investment advisor Corporate Knights are Dutch. In short, the Dutch are rather active indeed on this issue and we’ve already in fact come quite far. And we’re probably a lot further than where people thought we would be 5 or 10 years ago. So, whenever you feel the challenge is insurmountable, just think back to where we stood 10 or, if you go through a moment of particular pessimism, 20 years ago, and where we stand today. Hopefully the realization of how far we’ve progressed already, will give you enough energy to keep going. DNB initiatives The second consideration - because I promised you two - is that you are not alone in facing this challenge. Of course, there are all the signatories to the principles of this manifesto. But actually, your central bank and supervisor faces a similar challenge. You see, DNB, as I’m sure many of you know, has been quite active on the topic of climate risks: both on physical risks stemming from climate change, as well as on transition risks, stemming from legislation or market developments. About 2 years ago, we issued a report called Time for Transition. In this report we investigated the potential impact of the energy transition on the Dutch economy, and we noted that the upcoming transition is in fact one of the biggest medium to long term challenges to our economy and therefore for our financial sector. And a few weeks ago we published a report called Waterproof?, in which we took a closer look at climate risks in the Dutch financial sector. In this report, we concluded that in both a 1.5 degrees and 3.5 degrees scenario, climate-related damages are expected to go up due to an increase in the frequency and intensity of severe weather events. This means that insurance premiums may have to go up and that insurers may need to hold more capital, as they hold capital for severe events. We also found that models currently being used by insurers to predict damages do not adequately take climate change trends into account. In terms of the energy transition, we warned of risks stemming from new sustainability legislation for offices. The Dutch government requires office buildings to have a minimum energy label of C as of 2023. This means that all office buildings that don’t meet this requirement now, have five years to reach the required level, or their cash flows will dry up. Our financial sector finances large chunks of the real estate sector. When cash flows dry up, that will jeopardize the value of these loans. So how big is the problem? We found that on average 46% of bank loans to commercial real estate parties, has an energy label of less than C, representing some 6 bn euros. These loans run serious risks the coming years, and banks need to manage this risk. In doing so, by the way, they will discover, indeed they of course already have, that there are also ample and sound business opportunities to help their clients meet these legislative deadlines, thus creating a win win situation for business and climate. But that’s not all. As a follow up to this work, we are right now developing both physical and transition related stress tests. And we hope to present the results of the physical stress test in the coming few months. We’ve also done some work on the broader question of sustainable finance. About a year ago we published a report on responsible investing in the pension sector. This was based on a requirement in Dutch law for pension funds to be transparent as to whether and how pension funds take ESG factors into account. We assessed whether indeed all pension funds included their ESG investment policy in their annual report, and we shared the good practices that we saw. Last but not least, using our convening power, we’ve founded a national Platform for Sustainable Finance, which brings together our government, supervisors and industry representatives from the entire financial sector. The aim of this platform is to promote and encourage a dialogue on sustainable finance in the financial sector. In addition, the Platform also allows for financial institutions to form cross-sectoral working groups to tackle existing problems. One of these working groups, called the Platform Carbon Accounting Financials, or PCAF, has developed a methodology on how to measure the carbon footprint of six different asset classes. They will launch this report soon. Another working group has worked on SDG Impact Measurement. It developed, and recently launched its report, and I’m very proud that they’re here. So we’ve been quite active as you can see. And as a central bank and prudential supervisor, we’re actually rather proud of all the work we’ve done. And we’d even dare to say that we are among the frontrunners in Europe and perhaps even worldwide. A critical look at all initiatives… But if you take a closer look at the things we’ve done, perhaps we can also be a bit more critical. So far, most of our work is focused on climate-related risks. We’ve looked at how the energy transition could impact the economy, we’ve looked at how the financial sector is at risk from climate change and the energy transition. So if we’re a bit critical, from our supervisory mandate we’re mostly just focusing on climate risks. But isn’t climate just one of the SDGs? Aren’t there 16 other SDGs? And couldn’t each of these SDGs have physical or transition risks for our economy and therefore for our financial sector? Let’s take a look for example at SDG #15, Life on Land. Every year we gain 3.5 billion hectares of desert. And every year we lose 13 million hectares of forest. Biodiversity is also declining at an alarming pace. A recent study done in Germany showed that the average insect population has declines with 75% in the last 30 years. If governments don’t take action to stop the loss of biodiversity, this might for example one day lead to crop failures. And this might not happen slowly, but could perhaps be caused when we reach certain tipping points. If that were to happen, obviously, one of our basic human needs would be jeopardized. But from a financial point of view, agricultural companies might face difficulties, and that might impact banks financing the agriculture sector. And so it might not be too far reaching a thought that is would seem important for such a bank to be aware of potential risks from biodiversity loss. Or what about SDG #12, sustainable consumption and production? About making sure that we use all natural resources in a sustainable way? What if governments introduce legislation to ensure sustainable use of resources? Unsustainable companies would be relatively hard hit, and their profitability could be at risk. And thus, the financial sector that invested in them through stocks, bonds and loans. Move from 1 to 17? In short shouldn’t we move our work on sustainability from 1 to 17 SDGs? Couldn’t there be more risks than just climate? Need these risks not be managed? Should the prudential supervisor not broaden its focus? And what about impact? Couldn’t we do research into access to finance? Into potential bottlenecks for financing the SDGs? Couldn’t DNB have anything to say about striving for impact towards achieving the SDGs? Would that bring us to the fringes of our mandate? Or possibly beyond? The answer is not yet clear. Fortunately, this is exactly what we will look into in 2018. How do the SDGs fit in our mandate? It won’t be easy for us. We don’t have an exact answer. It’s pioneering. It’s challenging. It’s a struggle. But it’s one we’re happy to undertake. Even doing this, however, we’ll probably still fall short of the new paradigm advocated in the Manifesto. Because we would most likely be looking at each of the SDGs separately and assess to what extent they pose risks for the financial sector (both in terms of “physical” and in terms of “transition” risks). To the extent they do, we would squarely be within our mandate. But I know Eric will call for a more far reaching approach. Moving from risk to impact, and looking to all SDG’s holistically. So we have a lot of work to do. A lot of thinking to do, a lot of pioneering to do. The Principles and the Manifesto pose serious questions for serious times. Questions that we also ask ourselves and that we struggle to answer. So whenever you’re feeling like the task ahead of you is insurmountable, perhaps you will find comfort from the fact that your supervisor is struggling just as much as you are. But we’re all struggling in the right direction. | netherlands bank | 2,017 | 12 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Business Economists' Annual Dinner, London, 29 November 2017. | Modesty in times of uncertainty Monetary policy after the crisis Business Economists’ Annual Dinner (London, 29 November 2017) Speech by Klaas Knot Introduction Good evening everyone. Thank you for inviting me here to share my thoughts on monetary policy. We stand at an important turning point, 10 years after the global financial crisis began to unfold. During the crisis, monetary policy stepped in with unprecedented measures. At each new turn of the crisis, we as the Eurosystem took action and designed new policy measures where necessary. These measures proved successful. Now, a broad-based economic expansion is taking hold across the euro area. As the economy is enjoying robust growth, it is giving us the opportunity to take a step back from the crisis mode. Against this background, tonight I want to elaborate on the following. The current inflation outlook poses no threat to price stability. Despite undershooting its inflation aim in the near-term, the ECB is thereby fulfilling its mandate. This is thanks to a combination of monetary policy measures, including the Asset Purchase Programme, which has achieved what could reasonably have been expected. The slow inflation convergence towards our medium-term objective is due to global supply factors largely outside the realm of central banking. In this situation, continued monetary expansion is not a free lunch. Unconventional monetary policy is more intrusive than conventional monetary policy. It creates deeper market distortions that can generate misallocation and financial stability risks. As long as the standard economic relation between domestic slack and inflation, the so-called Phillips curve, fails to assert itself, adding ever more stimulus makes our policy increasingly procyclical, reinforcing these risks. I therefore want to argue for modesty in monetary policy-making. We need more emphasis on the medium-term orientation of our inflation objective. Patience is thereby of the essence. Absent deflation risk, a full phasing-out of net asset purchases from September 2018 onwards is warranted. Our communication will have to shift accordingly, from net asset purchases and incremental stimulus towards reinvestment and preservation of broadly accommodative financing conditions. A quick look back Let me begin by taking a quick look back. The euro area has endured some rough times. In the aftermath of the global financial crisis, the euro area weathered a sovereign debt crisis and a severe recession. These developments affected financial market actors, households, firms and governments. In an attempt to soften the impact of the crisis, the ECB took unprecedented monetary policy measures. Liquidity was provided in full allotment, and for longer periods than ever before. Interest rates were cut below zero, and several outright purchase programmes were set up. An indicator developed by the Dutch central bank shows that our actions were collectively equivalent to cutting short-term interest rates to around -4%.1 Faced with severe challenges, the Eurosystem responded forcefully. Being here in London tonight, allow me to highlight one crucial moment 5 years ago, when the functioning of sovereign debt markets in the euro area was severely undermined in the presence of redenomination risk fears. On July 26, 2012, our President Mario Draghi gave his famous “Whatever it takes” speech. Shortly after, the ECB announced its Outright Monetary Transactions (OMT) programme. Markets calmed down, in the knowledge that the central bank would intervene if needed. As they quickly realized the futility of speculating against the central bank in its lender-of-last-resort capacity, no purchases whatsoever were required under the OMT. This policy was successful on all accounts. Christiaan Pattipeilohy et al., “Assessing the effective stance of monetary policy: A factor-based approach”, November 2017. Chart 1: Euro area inflation Euro area inflation Annual percent change -1 HICP Core inflation (excl food & energy) Stemming a speculative attack on the integrity of your currency is one thing, controlling inflation is clearly a different ballgame. Whereas a central bank can credibly promise to do “whatever it takes” in lender-of-last-resort capacity, financial markets should not overestimate central banks’ ability to fine-tune inflation. Since the acute crisis abated, euro area inflation has been low and rising only slowly. As chart 1 illustrates, core inflation fluctuated slightly below 1% between 2014 and early 2017, and has yet to show more convincing signs of a sustained uptick. It is good to realize that stubbornly low inflation is not just a European phenomenon. Inflation in the US today, once corrected for imputed housing costs and thereby made comparable to our HICP measure, is actually lower than in the euro area, even though the economic and monetary policy cycles in the US are several years ahead compared to the euro area. The universal nature of subdued inflation is increasingly linked to favourable supply-side developments such as technological advances and globalisation of product, labour and capital markets. The resulting disinflationary factors are global in nature and largely outside the realm of individual central banks. They have altered domestic inflation processes and have thus complicated the life of central bankers around the world.2 Chart 2: Euro area GDP growth Euro area real GDP growth Quarter-on-quarter percent change 1,0 0,8 0,6 0,4 0,2 0,0 -0,2 -0,4 -0,6 The inflation outlook I would nonetheless argue that the current low inflation rates, despite falling short of our medium-term objective, do not constitute a threat to price stability. The current inflation outlook should be assessed against the background of a robust expansion of the eurozone economy. As chart 2 illustrates, the euro area is currently enjoying its fifth consecutive year of GDP growth. Since mid-2014 this growth can also be dubbed “reflationary”, in the sense that quarterly growth readings have consistently outpaced potential growth rates. Claudio Borio, “Through the looking glass”, OMFIF City Lecture, London, 22 September 2017. Against the backdrop of a reflating economy, the inflation outlook is consistent with our aim of an inflation rate of below, but close to, 2% over the medium term. It should be emphasized that from the ECB’s early days onward, the medium term has been defined as a flexible concept. It depends on the shocks hitting the economy and the efficacy of the monetary policy transmission that should bring inflation back on target. The global financial crisis was arguably much deeper than the average shock foreseen at the euro’s inception, and the financial fragmentation it created within the euro area severely impeded monetary transmission. In a context of such widespread financial imbalances, the ECB’s first chief economist, Otmar Issing, argued that “there is little sense in continuing to pursue an inflation forecast for consumer prices over a horizon of one to two years. In such circumstances it may instead be advisable to set interest rates with a view to a time frame extending well beyond conventional forecast horizons.”3 Concerns have been voiced that a prolonged period of low inflation could lead to a de-anchoring of inflation expectations. While the conceptual relevance of this argument is beyond dispute, there are some challenging issues in operationalising it in the monetary policy process. Market-based and surveybased measures of inflation expectations exist, but they both come with a range of caveats and have often provided conflicting signals as to whether inflation expectations were anchored or not. Moreover, the mechanism by which inflation expectations affect actual price- and wage-setting behaviour is far from understood. I therefore sympathize with former Fed Governor Dan Tarullo, who recently argued that “inflation expectations are bearing an awful lot of weight in monetary policy these days, considering the range and depth of unanswered questions about them”.4 Otmar Issing, “The ECB and the euro - the first five years”, Mais Lecture at the City University Business School, London, 12 May 2004. Daniel Tarullo,”Monetary policy without a working theory of inflation”, Hutchins Center working paper #33, October 2017, and “Fed has no reliable theory of inflation, says Tarullo”, Financial Times, 4 October 2017. All in all, I am confident that our monetary policy measures will continue to work their way through the transmission mechanism. Also at current low inflation rates the ECB is fulfilling its price stability mandate and successfully protecting the purchasing power of European citizens. Current policy stance So where does this assessment leave me in terms of the current monetary policy stance? After all, the crisis is several years behind us, the economy is enjoying solid expansion, price stability is not in jeopardy, yet many of our unconventional monetary policy measures are still in place. Liquidity operations are still conducted under fixed-rate full allotment, significant volumes of Targeted Longer-Term Refinancing Operations are still outstanding, and the deposit facility rate is still in negative territory. But the measure that has attracted most controversy in the recent years is our Asset Purchase Programme (APP). As you will be aware, the programme has just been extended until at least September 2018, albeit at a reduced pace of 30bn a month. As stated in our Introductory Statement, “The recalibration of our asset purchases reflects growing confidence in the gradual convergence of inflation rates towards our inflation aim.” Although at past occasions I have been sceptical about the APP’s effectiveness with respect to raising inflation, the APP has contributed to four important achievements which I would like to recall here. First, the APP has further eased financing conditions across the euro area up to the point where borrowing costs are no longer an impediment to whatever spending decision. This also means that since monetary policy constraints have become de facto non-binding, the marginal benefits of further accommodation are negligible. Second, financial fragmentation between euro area countries has been reduced and monetary transmission has become much more homogeneous across Member States than was the case during the crisis. Third, the APP has supported the strong economic expansion I talked about earlier. Fourth, and perhaps most importantly, the tail risk of a 1930s type deflationary spiral has been averted. In doing so, the programme has achieved what could reasonably be expected from it. With deflation risk clearly off the radar, the main rationale for employing the APP has therefore ceased to exist. Fear of relapse owing to an alledgedly premature discontinuation of net purchases seems rather overdone. The programme has simply run its course. Continuing the programme for the sake of fine-tuning inflation rates to precise values below, but close to, 2% suggests a degree of control over the inflation process that is at least debatable. Risks and side effects At the same time, continued monetary expansion is not a free lunch. Unconventional policy measures can have unconventional consequences that even professional economists cannot always oversee. A prolonged period of low interest rates, ample liquidity and prominent central bank intervention in markets has given rise to potential misallocation of credit and wider resources toward zombie firms.5 Risk premia are compressed to a point where they no longer reflect the assets’ inherent risk characteristics. The dynamics of preventing financial markets to adequately price risks for an extended period of time takes our economies into largely uncharted territory. These financial stability risks also need to be considered when assessing our monetary stance. While some would argue that prudential and not monetary policies should address financial stability risks, I tend to agree with former Bank of England deputy Governor Charles Bean that there are “important qualifications to this somewhat Panglossian view of the ability to maintain both price stability and financial stability by assigning monetary policy to the former and macroprudential policy to the latter.”6 After all, only monetary policy sets “the universal price of leverage”.7 Conversely, materialization of financial stability risks can also become detrimental to price stability. Viral Acharya, Tim Eisert, Christian Eufinger, and Christian Hirsch, “Whatever it takes: The real effects of unconventional monetary policy”, SAFE Working Paper Series, No. 152, 2017. Charles Bean, “The future of monetary policy”, speech at the London School of Economics, London, 20 May 2014. Claudio Borio and Mathias Drehmann, “Financial instability and macroeconomics: bridging the gulf”, September 2009. Procyclicality In the current context, financial stability risks interact with the issue of procyclicality. The failure of the traditional Phillips curve relation between the business cycle and inflation to thus far assert itself makes monetary policy increasingly procyclical. Economic growth in the euro area passed its cyclical trough in the first quarter of 2013, while core inflation bottomed out early 2015. Yet until at least September 2018 the APP will be adding stimulus. Not only in terms of length, but also in terms of magnitude of the expansion, the economy is in outstanding shape. With real GDP growth hitting levels above 2% year-onyear, the monetary policy stance is increasingly out of sync with the business cycle. Chart 3: Euro area business cycle and monetary policy decisions Euro area business cycle and monetary policy decisions PMI number on y-axis, with 50 marking difference between business cycle expansion and contraction 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 Mean of PMI +/- ½ standard deviation Composite Purchasing Managers’ Index (PMI) index Policy easing (rate decrease or APP decision/expansion) Policy tightening (rate increase) A simple historical comparison serves to illustrate this point. Chart 3 shows that during previous upturns, that is when the euro area composite Purchasing Managers’ Index (PMI) stood at similar levels above its long-term mean, policy was generally tightening instead of the current prolonged easing.8 Obviously, the main factor underlying this contrasting pattern is the weak and elusive character of the traditional Phillips curve relationship between cyclical conditions and inflation. Whether this is merely a temporary or a more permanent phenomenon is a topic for ongoing debate. My colleague Mark Carney, for example, has recently argued that “globalisation has been accompanied by a weakening in the relationship between domestic slack and domestic inflation, and by a corresponding strengthening between global forces and domestic prices”9. Also in the euro area, the strong recovery of the labour market has yet to translate into upward pressure on wages and prices. Communication Patience is therefore needed for our monetary stimulus to unfold. The reflating economy will ultimately translate into increased pressure on wages and prices. This may however take time. Central banks can only affect the price level with “long and uncertain lags”. Consequently they cannot be over-ambitious and try to steer price developments in the short run, nor should they seek to precisely define the horizon of their action.10 As we intend to reinvest maturing securities for an extended period of time, financial conditions will likely remain accommodative long after net asset purchases will have come to an end. In view of the above, we have to adjust our communication. With a medium-term focus in mind, we need to highlight patience and confidence in the measures that we have already taken, while at the same time remaining realistic about what our measures can and cannot achieve. We will need to cater for the possibility that a sustained adjustment in the path of inflation (SAPI) can only be achieved well after net asset purchases will have come to an end. Fortunately, our Moreover, data since the 1960s show that once the recovery took hold, the first policy rate increase has typically taken place after 10 quarters in Germany and 11 quarters in the US, on average. As indicated earlier, the current euro area recovery is enjoying its 19 th consecutive quarter of growth. Mark Carney, “[De]Globalization and inflation”, 2017 IMF Michel Camdessus Central Banking Lecture, 18 September 2017. Otmar Issing, “Inflation targeting: a view from the ECB”, “Inflation Targeting: Prospects and Problems” Symposium St. Louis, 16-17 October 2003. monetary policy stance is more encompassing, and all our measures are geared towards this objective. The focus in communication therefore needs to shift to the other elements of our policy toolkit, such as forward guidance on key policy rates, together with the ongoing stimulus provided by the stock of our asset purchases. Conclusion Let me conclude. Our economy is in the midst of a strong cyclical upswing. Farreaching policy measures have contributed to cement growth, avert deflation risk, and enhance the cohesion of the monetary union. Although raising inflation towards our aim is taking longer than expected, current inflation rates are not a threat to price stability. With actual growth exceeding potential and labour market slack falling, inflationary pressures will eventually unfold. At the same time, the longer the Phillips curve fails to assert itself, the more procyclical policy might become, and the greater is the likelihood of financial stability risks building up. Patience and confidence should therefore replace suggestions of openendedness in our communication. Absent deflation risk, a full phasing-out of net asset purchases from September 2018 onwards is warranted. Preservation of existing stimulus will be more than sufficient to reach our inflation objective, albeit at a medium term that may be further away than many of us are used to. Let me then end with the more than relevant words of Augustus William Hare, “True modesty does not consist in an ignorance of our merits, but in a due estimate of them". Let us be modest and take a realistic look at what our measures can and cannot achieve in our efforts to maintain price stability. I thank you for your attention. | netherlands bank | 2,017 | 12 |
Speech by Mr Job Swank, Executive Director of the Netherlands Bank, at ESB's Conversation with Regulators on Innovation in Payment Services, The Hague, 18 January 2018. | PSD2: WILL IT BE A GAME-CHANGER? Speech by Job Swank, Executive Director of De Nederlandsche Bank at ESB’s Conversation with Regulators on Innovation in Payment Services, 18 January 2018 in The Hague 1. Introduction • Ladies and gentlemen, I’m grateful to the organizers of this conference for inviting me here. This Conversation with Regulators is the last in a series of events on innovation in payment services, organized by ESB. For those of you who can read Dutch, I highly recommend the dossier Innovatie in Betalen, issued by ESB in September. It has much more to offer than you will hear from me today. • Today’s topic is PSD2. PSD2 is a European directive, to be implemented through national legislation. And PSD2 is about payments. To most people, these topics – legislation and payments – are extremely boring, a necessary evil. Probably not to you. Otherwise, you wouldn’t be here, but you are certainly a minority. • But life will change for the better, at least according to innovators, fintechs and other market suppliers. Customers can be disencumbered from the tedious activity of making a payment. They may enter a shop or webshop, pick whatever they want and have the shopkeeper take care of the payment … which will be the end of civilization as we know it. Or perhaps even more sophisticated: refrigerators, printers and other home appliances can order their own refill … and arrange for the payment without intervention of the consumer. A bank customer may receive an offer from a mortgage broker, perfectly geared toward her financial position and spending pattern … before she even considers buying a house. • This is not the future, this is now. Those services – if that’s the proper term to use – are technologically feasible and supplied as we speak. So, the question is not whether or when we will enter into a new era (we already have), but rather on what scale. This very much depends on the receptiveness of the public at large and on the reactions of regulators and supervisors to the new possibilities. • PSD2 is the response of the regulators. It is a response that facilitates innovation. It compels banks, payment institutions and other players to prepare for an era in which financial services are mainly delivered through smartphones, tablets and other electronic devices. • DNB welcomes PSD2 and the associated innovations. Still, a number of issues are pending. Customer privacy is the most salient one, but there are more challenges: on the demand side, on the supply side and with the regulators. The rest of my talk is organized along this triplet: demand, supply and regulation. I do not have definite answers to all pressing questions related to PSD2. What I’ll try to do, is give you a concise impression of issues that need further attention in the near future. 2. PSD2 and the demand side: consumers and retailers • Let’s start with some basics. What is PSD2? PSD2 is the legal framework for retail payments in the European Union. The radical new element of PSD2 is attractive for some, and frightening for others. That is: a bank is obliged to give so-called service providers online access to the account of a customer … if – and only if – the customer consents. This is an important proviso. The service providers exist in two types: the ones that initiate payments and the ones that extract and exploit information from bank accounts. Such data – on all kinds of transactions – contain commercial value. The collected information can also be redirected to the bank customer as a housekeeping book. Both types of service providers will be regulated under PSD2. • What is the intrinsic demand for innovative payment services? The novelty of PSD2 is primarily concerned with payments connected with e-commerce. Two facts. First, those payments are still a small portion of the market. Right now, only 2 percent of total payments in the Netherlands. Second, there are already several ways to pay online: through credit cards, by PayPal and, in the Netherlands, through iDEAL. What else would you need to become a happy payer? I hasten to say that this question may be rather silly. The story goes that Henry Ford once sighed: “If I had asked my customers what they wanted, they would have said … faster horses”. Paying online in the Netherlands is quite easy, also compared to other countries. Moreover, already next year, the ideal of 24/7 instant payments will be realized for mobile and internet payments. But judging from the excitement in the industry, plenty of new P2P applications are likely to be within reach. • What are retailers interested in, as for payment methods? Reach, user convenience, conversion time and – last but not least – cost. Larger retailers may have an incentive to offer payment initiation services themselves, hence bypassing their banks and avoiding bank fees. From this angle, PSD2 may certainly become a game changer. • The future need for account information services is also difficult to assess, at least where consumers are concerned. Account information services can emerge as smartphone apps that give the customer an up-to-date overview of her payments and financial position. This may be quite useful to analyze one’s expenditures, when a financial advice is needed, or some financial product. I assume that most people acknowledge the benefits of such a service, especially if information from several accounts is combined. But this is probably just the beginning of the further use of payment data. While the exploitation of account information is extensively regulated, it is a very delicate matter. I will not go into the possibilities and horror stories connected with the commercial use of payment data (incidentally, the industry prefers the term “customer intelligence”). But let me elaborate a bit on two contradictory attitudes with the general public when it comes to privacy. • In 2014, ING announced it considered to use payment data of its clients for commercial purposes. You may remember that this caused a national outcry on privacy. So fierce that soon after the announcement, ING decided to abandon its plan. A recent survey by Carin van der Cruijsen, a researcher at DNB, confirms that the Dutch public is very reluctant to share their payment data with third parties, even for innovative services. An effective way for banks to lose client confidence is to publicly hint at selling customer data to other firms. At the same time, most people are frightfully willing – or unconscious – in allowing internet firms like Google to tap and exploit their search activities on the Web. • Of course, the European legislator has been fully aware of the privacy concerns. PSD2 provides for a number of requirements regarding the use of data and data protection. In addition, the General Data Protection Regulation (GDPR) will become applicable soon. But certain issues on privacy are still pending, mainly due to possible contradictions between PSD2 and the GDPR concerning consent [, which is the legal basis for the provision of payment services and the use of account information]. More work is needed on this score by prudential and privacy supervisors. In the Netherlands, this requires close cooperation between the Dutch Data Protection Authority and DNB. PSD2 and the supply side • Payments business is a network industry. The entrance of new users – be it consumers or retailers – increases the value of the network for all players. There are substantial economies of scale, due to network externalities and also because setting up a payment infrastructure requires large amounts of investment. This infrastructure is traditionally offered by banks. However, the network effects may raise entry barriers on the supply side, as well as lock-in effects on the demand side. These, in turn, may become obstacles to innovation and competition. One way to overcome such obstacles is to separate the provision of payment services from the infrastructure. This is exactly what PSD2 intends to achieve to stimulate competition and innovation. Banks maintaining the infrastructure, new players providing new services. • But this solution gives rise to new concerns. The first is the risk of fragmentation. The potential benefits of PSD2 might be frustrated if banks and payment service providers would communicate by a wide diversity of technical interfaces. Common standards help to create a critical mass and to incite new players to enter the market. Standardization is not provided for by PSD2 or its lower regulations. For good reasons, as regulations should be technologically neutral and principle-based. Thus far, principles on standardization could not be agreed in the Euro Retail Payments Board either, due to conflicts of interest between banks and the new payment service providers [screen scraping, among other things]. So, the question remains how standardization can be achieved without creating one dominant force. I will come back to this shortly. The answer may be further cooperation between banks and the new service providers to come to standards that will be broadly accepted in the market. As long as competition is not hindered, of course. That is the real challenge. • The second, related, concern is the potential role of BigTech. PSD2 makes it easy and attractive for BigTech companies like Google and Apple to enter the European market as payment service providers. If these companies were given a license, they would get access to the accounts of bank clients and acquire the right to use payment data, provided that the customer consents. Like other service providers, they will have to comply with PSD2 and the General Data Protection Regulation. But BigTech companies have a clear competitive advantage when it comes to global brand awareness, international reach and financial resources. Hence, they may oust smaller players and obtain a dominant market position. “Winner takes all”. This is probably not the best outcome for Europe and certainly not in the spirit of PSD2. The big – unanswered – question is, then, how to avoid it. • How should small players get the chance to develop. Loosely speaking, PSD2 gives them the right to access bank accounts; again, if the customer consents. But this is only their legal position. Can they survive if BigTech penetrates into the market? Will they be squeezed, then, between the incumbent banks and the new big players? Not necessarily! There is an increasing tendency for banks and fintech companies to work together. Banks provide a large customer base, capital and regulatory experience. The fintechs, in turn, offer specialist expertise and agility in product development. For them, the proverb “If you can’t beat them, join them” seems to apply. • Another concern or challenge is: what does PSD2 imply for the business models of banks? Banks provide and maintain the infrastructure, which the new players can use freely to supply their services. Banks cannot charge for the access, for information requests or for the use of their infrastructure. So, banks may need to review and adapt their business models. Fortunately, PSD2 also provides banks with new business opportunities. They can decide to become payment initiation service provider or account information service provider and offer their customers the new services themselves. They can reorganize themselves, create agile teams of young and creative people to develop innovative tools, based on access to the account. This is already happening. And, of course, they can closely cooperate with fintech companies. 3. PSD2 and the payment system • It is also important to look at the system as a whole. This is where DNB comes in. DNB is entrusted with the prudential supervision of banks and payment service providers settled in the Netherlands. DNB is also the central bank. In that capacity, it is legally mandated to promote a sound functioning of the payment system. • PSD2 gives financial supervisors a prominent role in maintaining the security of payments in the EU. PSD2 not only creates business opportunities, it may also change banks’ risk profiles. Operational risk in particular is likely to increase. This includes cybersecurity, digital fraud and the risk of mismanagement of personal data and privacy. New service providers are also exposed to these risks. Banks, in addition, may have to adapt their business models, which creates a strategic risk. On the other hand, individual banks prosper to the extent that they can exploit the new opportunities that PSD2 offers. Supervisors and central banks will have to monitor these new risks and developments, both for individual banks and from a system perspective. This is not something new. But the playing field may become in a constant state of flux over the next decade, posing new challenges to the authorities. • As a central bank, DNB welcomes PSD2 and the associated innovations. By increasing competition, PSD2 can make the payment system more efficient. There are at least three unresolved issues, though, which will come to the fore sooner or later. First, banks are expected to maintain the infrastructure for payments, which the new players can access for free. Then, the strategic question arises whether there will be sufficient incentives for banks to invest further in the infrastructure. Second, the payment system as a whole may become more complex and more fragmented, due to a lack of standards. Is this a problem that needs intervention by the competent authorities or can it be solved by the industry itself? It may serve as a warning here that, until now, European stakeholders have not been able to develop a standard interface for access to bank accounts. Third, if BigTech penetrates into the European market, who should organize the countervailing power to prevent market dominance. And how could this be done? 4. Concluding remarks • Let me conclude. PSD2 compels the payment industry to head for a new digital era. This may have major strategic consequences for online payments. In my address, I have raised a series of questions on privacy, on the potential role of BigTech and on the conceivable prospect of a fragmented payment system. While DNB welcomes PSD2, these questions deserve ample further reflection in the coming years. • I thank you for your attention. | netherlands bank | 2,018 | 1 |
Keynote speech by Mr Klaas Knot, President of the Netherlands Bank, at the Bundesbank Symposium "Banking Supervision in dialogue", Frankfurt am Main, 7 March 2018. | “From mission to supervision” Key note speech by Klaas Knot at the Bundesbank Symposium ‘Banking Supervision in dialogue’ Frankfurt, 7 March 2018 In his keynote speech, Klaas Knot outlines how the issue of ‘sustainability’ got on the DNB agenda, highlighting how and why sustainability is relevant for central banks, supervisors and the financial industry. Secondly, he gives an overview of the climate-risks in the Dutch financial sector. Third and finally, he sketches what this means for bank risk management and supervision. Introduction Dear herr Dombret, herr Otto, thank for your kind introduction, and thank you very much for having me. It’s a great privilege for me to speak to you at this Symposium Banking Supervision in Dialogue. Let me begin though by highlighting that if I would have told you 5 years ago that today at this very Symposium ”Bankenaufsicht im Dialog”, we would spend half the day discussing sustainability, not only would none of you have believed me, but most likely many of you would have taken me for a sort of tree hugger rather than a central banker. And yet here we are today. It’s a clear indication of the significant shift in thinking that has occurred in the financial sector and in the supervisory community over the past few years. Sustainability has become more and more part of mainstream finance, evidenced by so many initiatives and examples worldwide, of which the Sustainable Finance Action Plan, which the European Commission will publish tomorrow, is only just the latest. At De Nederlandsche Bank, which is both the central bank and the supervisor of banks, pension funds and insurance companies, we have been active on the issue for a few years now. I can imagine though that many of you might be wondering why we have been active on this issue for a few years already. What happened there? Today, in my speech ‘From mission to supervision’, I want to share with you precisely what happened. I will firstly share how this issue got on our agenda, highlighting how and why sustainability is relevant for central banks, supervisors and the financial industry. I will then turn to a thematic review of climate-risks in the Dutch financial sector that we did in 2017, which led to a publically available report, called Waterproof. As Andreas has already explained to you how and why our economies and financial sectors could be impacted by climate change and the energy transition, I will not bore you with repeating that. Instead, I would like to share with you the outcome of our thematic review on the risks we are seeing for the Dutch financial sector. Third and finally, I will say a few things on what this means for bank risk management and supervision. All in the hope that we all will walk away here with a better understanding of how sustainability can affect our different organizations. And convinced that it makes perfect sense to incorporate sustainability into our day-to-day operations. I. Mission: Sustainability on the agenda of DNB Let me begin by explaining how sustainability got onto the agenda of DNB, thereby also showing in the process why this issue fits the mandate of central bank and supervisor. You see, not too long ago, sustainability to us just meant we should ensure that our coffee cups were made out of sustainable paper, and that the coffee in those cups was fair trade. Sustainability was something we certainly thought that was important, but it was not something that concerned our core tasks or our strategy as an organization. (And I’m guessing we were not the only organization to think like this.) That changed in 2011 though, when the newly appointed board of DNB concluded that probably this was the appropriate time to update the mission statement. We had to answer the question: what is our Existenzberechtigung? It’s something I’m sure many of you have had to deal with as well, whether as a supervisor or as a commercial bank. Mind you, this happened in 2011, when we had just lived through the Global Financial Crisis. Europe was still in the midst of a sovereign debt crisis, and emergency measures were taken all around us. It had become clear to us, the new board, but also to many bankers and many economists we talked to, that a significant part of the economic prosperity that our societies had created in the early 2000s, had been based on excessive leverage. Our economies had seen too much credit growth, which was not adequately backed up by underlying strong economic and financial fundamentals of companies, households and even of governments. All of these developments were in the back of our mind when we had to come up with that new mission statement for DNB. One obvious implication of all of this being at the back of our mind, was that safeguarding financial stability was to be a crucial part of this mission. Another implication was that we wanted to incorporate an element of the general good of the societies we serve, contributing to increases in living standards and prosperity of those we serve. But there was something more, relating to all those crisis developments I just mentioned. Hadn’t the crisis taught us that the prosperity we had created in the years before the financial crisis, had proven to not be durable in the long run? Put differently, the prosperity had turned out to not be sustainable. Because that’s what sustainable means: durable in the long run. And so, as we were walking down a foggy beach in Zandvoort, trying to come up with this new mission statement, we fortunately had the clarity of mind to add the word ‘sustainable’ before the word ‘prosperity’. Our mission as central bank and supervisors became “to safeguard financial stability and thus contribute to sustainable prosperity in the Netherlands.” Now, of course, as we added the word ‘sustainable’ to our mission, our main thinking was in relation to the economic and financial crisis. Sustainable prosperity meant, for example, that banks should have sufficient buffers to absorb unexpected losses. But it soon became clear that the word sustainable could have broader implications. After all, if the way in which prosperity is created today results in significant ecological damage that prevents future generations from obtaining similar or higher levels of prosperity, today’s prosperity creation is not sustainable either. And as such, it runs counter to our mission. Of course, having a mission is just the start. As I’m sure all of you know, any policy determined at the top needs to be embedded throughout the organization to be truly effective. Therefore our policy became to incorporate relevant sustainability considerations in most of our core tasks. Of course the extent to which sustainability can and should be incorporated, depends on each of the individual tasks that a central bank/supervisor may have. And I’m sure that the extent to which sustainability can and should be incorporated for financial institutions, will not only depend on which type of institution you are - a bank, a pension fund or an insurer - but may also differ per institution as well. For some of our own core tasks, it was quite practical. In our payments systems task, for example. We are probably one of the only central banks in the world where 70% of our bank notes are now made out of either fair trade or organic cotton, and our goal for 2019 is to reach 100%. For other core tasks, it was more conceptual and theoretical. As part of our economic research and advisory function, we published an exploratory study called Time for Transition. In it, we identified the upcoming energy transition, as agreed upon by more than 190 countries in Paris in December 2015, as one of our economy’s key long-term challenges. In the report we urged our government to pursue a plausible and practicable path towards a carbon-neutral economy, as such a long-term view enables households and businesses to gradually adjust their investments, preventing excessive misallocation. And we also decided to take a closer look into climate risks for the Dutch financial sector as part of our supervisory mandate. II. Risks: a thematic review of climate risks in the Dutch financial sector Which brings me to the second part of this speech. What are the risks that we see as a supervisor in the Dutch financial sector? In 2017 we conducted a thematic review on this issue. In this review we took a deep dive into four topics: - climate-related damages for the insurance industry - risks for the financial sector from a potential flood - risks from the financing of carbon intensive assets, so called ‘brown finance’ - risks from the financing of assets and projects that are meant to contribute to the energy transition, so called ‘green finance’. Today I want to share with you some key findings for banks, regarding the risks for brown and green finance. In terms of brown finance, one of the things we wanted to do was get an understanding of the size of the risks. How big of a risk is the energy transition for our banking sector? As a first step, we wanted to measure how exposed our financial industry is to sectors that need significant reforms to become carbon neutral. Sectors such as fossil fuel producers, the utilities industry, heavy industry, agriculture and transportation. This wasn’t something that we could easily get from our supervisory data. Which is why we welcome the work that the Commission will do on developing a taxonomy for the sustainability of financial assets as part of their Sustainable Finance Action Plan. For our research, however we had to develop our own template for our financial sector to fill out. We sent this template to the three biggest banks, covering around 70-80% of the market. What we found is that banks’ balance sheet consist of around 11% of exposures to carbon intensive industries. Not surprisingly, most of these exposures are through loans, which makes banks less sensitive to market fluctuations than for example pension funds. Moreover, most of these loans have maturities of less than five years, which should provide banks with sufficient scope to anticipate changes. Especially if the transition is more gradual in nature. In one area however, we already see transition risks materializing, and that’s in the real estate sector. The real estate sector plays an important role in carbon emissions and is therefore sensitive to the energy transition. In the EU, many, if not all, residential and commercial real estate have energy efficiency labels, ranging from A to G, with G being the least energy efficient building. The Dutch government has announced legislation that requires almost all offices in the Netherlands to have a minimum energy efficiency label of C by 2023. Any office that doesn’t meet that requirement can no longer be used. This affects banks in two ways. First, through loans to regular corporations, who use their own offices as collateral for their bank loans, and second, through loans to commercial real estate companies that lease offices as a business model. If some of these offices may no longer be used, or will need to be upgraded to meet the requirement, this could affect the value of the collateral or the ability of commercial real estate companies to pay back their loans. So how big of an issue is this for our banks? Unfortunately, neither we nor our banks know the energy label distribution of the offices used as collateral for loans to regular corporations. For loans to commercial real estate companies, banks know of roughly 50% of those loans what the energy label distribution is. Of those loans where we did know the label distribution, we found that 46% of bank loans to commercial real estate companies in relation to offices, have an energy label lower than C. This is around 6bn worth of loans. All these loans, one could say, have elevated credit risks, which banks, one way or the other, will need to manage. Fortunately, we are seeing many banks react swiftly. Banks are now demanding that any new loan or refinancing of existing loans in relation to those offices is dependent on the client meeting the energy-label requirement on time. This should ensure that banks will have limited exposures to offices that won’t meet the deadline on time. For us, this national legislation is a prime example of how the energy transition will lead to risks in the financial sector. We also looked at the risks of green finance, as I mentioned. First there is the risk of a green bubble. History shows us that many transitions are accompanied by a boom bust cycle, whether it’s the dot-com bubble in the early 2000s, or the railway mania of the late 1900s. Whenever there’s increasing demand, a hype, or new market opportunities and instruments, there’s the risk of creating a new bubble. While we are still far away from a green bubble, institutions do tell us that green projects have become more and more expensive, as competition has increased with more and more institutions essentially bidding for the same projects. A second risk we see is green washing. Do investors and consumers know what green is, when they’re buying green? There are examples of a green bond being used to make a coal plant more sustainable. In itself, there is nothing wrong with that, or at least that’s not for us to say, but what is important is that purchasers of these bonds should be aware of this. Here, too, the work of the European Commission on a sustainable taxonomy as well as on standards for green bonds, will be most welcome. Lastly, we are seeing an increased lobbying effort to lower capital requirements to stimulate green investments. Andreas has already touched upon this, so I won’t repeat that, other than that we wholeheartedly agree: capital requirements should remain risk based. We are thus quite skeptical of the expected plans of the European Commission in relation to prudential requirements, even though they also acknowledge the risk based nature of capital requirements. III. Supervision: Implications for bank risk management and supervision So let me end with what this all means for bank risk management and supervision. The main conclusion is that banks, including those present today, will need to manage material climaterelated risks. And that supervisors will need to supervise this. This is of course easier said than done. If anyone in this room already knows how to exactly manage climate-related risks, please join us at the podium in a minute! Two things are important to keep in mind here. One: incorporating climate risks is greatly facilitated when governments impose clear and long term transition legislation, which gives banks the ability to steer towards a set of well-defined goals. This is exactly what we are seeing with the energy efficiency requirements of Dutch offices. Two, for many parts of our economies, unfortunately there is not yet any clear legislation that allows banks to anticipate such a set of well-defined goals. In those cases, banks would still do well to try and gauge how their business models and which parts of their balance sheets would be most strongly affected by the transition and which type of legislation or technological change might be expected in those sectors. It would then be prudent to try to assess potential losses as a result. Scenario analysis and stress testing would be a good tool for this. Put differently, institutions will need to take a more forward looking approach to incorporate climate related risks. This process can fortunately be helped by implementing the recommendations of the FSB Taskforce on Climate-related Financial Disclosures. Implementing the recommendations means you will need to explain your governance, risk management and strategy on climate related issues. And you will need to explain which metrics and targets you use to prepare yourself on these issues. And all of this of course means you need to have a strategy, risk management and governance system on this issue. And that you subsequently need to have targets and metrics to measure your progress in these areas. Fortunately we are seeing many financial institutions in the Netherlands and abroad experimenting with incorporating climate risk management. One Dutch bank for example, has incorporated the energy transition into its credit policies for loans to the utility industry. This bank will only finance utilities that have carbon reduction strategies, and the bank wants the average energy mix of the utility companies it finances, to be in line with the 2 degree scenarios from the International Energy Agency. This is precisely the kind of thinking and attitude we need, to start incorporating climate risk considerations into investment decisions. It won’t be easy, and I’m sure it won’t be perfect at first either, but we need to start somewhere. How to precisely incorporate climate-related risks into banking supervision also remains an open question. Here too, the same two points stand out. One, when risks are already material, we can of course already assess them. If Dutch banks for example were ignoring the increased credit risk from the sustainability requirement for offices, you can be sure we would be in a serious supervisory dialogue as part of the Pillar 2 credit risk assessment. But that’s of course just one very specific example, where there is specific transition legislation affecting only a small part of our economy. It’s more challenging for the energy transition as a whole and for banks’ balance sheets as a whole. How should supervisors assess how well banks are incorporating climate-related risks there? Do we need to establish a separate risk category in the Supervisory Review and Evaluation Process as some European Parliament members are proposing? Or can and should we just incorporate it into the existing SREPelements, such as for example credit risk? We don’t have all the answers yet, but we will continue to explore these questions in the years to come, and we hope you will join us. One thing should be clear though: sustainability factors, and climate issues in particular, can affect the solidity of financial institutions, and therefore warrant the consideration of banks and supervisors alike. Fortunately, just a few months ago, central banks and supervisors from 8 jurisdictions, including Germany and the Netherlands, launched the Central Banks and Supervisors Network for Greening the Financial System. This Network aims to enhance the role of the financial system to manage risks and to mobilize capital in the transition to an environmentally more sustainable world. My colleague, Frank Elderson, was recently elected as the first chair of this Network. I am grateful and excited that DNB and the Bundesbank will work together in this Network to advance this issue in the international supervisory community. Conclusion Ladies and gentlemen. Today we went from mission to supervision. I hope that the transition that DNB underwent as an organization, where relevant sustainability-considerations have been incorporated into our core tasks, has inspired you or perhaps has even sounded familiar. But I can also imagine that some of you might remain skeptical on the appropriateness of all this. Perhaps some are still wondering: are we really discussing sustainability today? For those I would like to share something my colleague Jan Sijbrand said to me recently: “Klaas, when it comes to sustainability, we are being criticized from both sides: there are those who say we are operating beyond the boundaries of our mandate. But there are also those who say we are doing way too little.” “To me”, he said, “That’s a clear sign we’re exactly on the track we should be.” And with that I would like to conclude for now. Thank you. | netherlands bank | 2,018 | 3 |
Opening speech by Mr Klaas Knot, President of the Netherlands Bank, at the first International Climate Risk Conference for Supervisors, Amsterdam, 6 April 2018. | Dear Governors, Deputy Governors, Executive Directors, and Board Members, Dear Chairs, Secretary Generals and Director Generals, Dear Supervisors, Regulators and Market Participants, And dear members of the organizing committee, Dear Everyone, Welcome to the first ever International Climate Risk Conference for Supervisors! It is our sincere pleasure to welcome you to the beautiful city of Amsterdam to discuss how climate-related risks could affect our financial institutions, and thus affect our mandate as a central bank and supervisor. This conference is organized not only by ourselves but also by the ACPR and the Bank of England, and the conference is an initiative of the Network for Greening the Financial System, which was launched in Paris in December of last year. This Network aims to strengthen the global response required to meet the goals of the Paris agreement and enhance the role of the financial system to manage risks and to mobilize capital for green and lowcarbon investments. We are very proud to have representatives with us today from over 30 countries and from more than 50 supervisory organizations. We have participants from as far away as Australia, Japan, and Canada, and from as close to home as Germany, Belgium and Luxembourg. In short, we have a gathered a truly international crowd here today. And while some of you may have been active on this issue for a while, I can imagine that for many others today might the first time you are engaging with this issues. We hope it will be a fruitful exchange. Now, I shan’t dive into the details of how climate risks could affect our financial sector, as I’m sure we will be discussing those risks in the coming hours, with all the excellent speakers we have lined up. What I would like to share with you is why we have been active on this issue for a few years now. But it is only logical that some of you might have some scepticism about supervisors being worried about the climate. Maybe you will be less puzzled after I will have told you how we as central bankers and supervisors started worrying. It all revolves around our mission. I’m sure that some of you may have heard that already before. But it’s important to highlight this mission, because it explains perfectly why it makes sense for supervisors and central banks alike to pay attention to the issue of sustainability. You see, De Nederlandsche Bank is the supervisor of banks, pension funds and insurance companies, but also the central bank, the resolution authority and the authority for the deposit guarantee scheme. And our mission is to safeguard financial stability and thus contribute to sustainable prosperity in the Netherlands. Financial stability is of course a key component of this mission. But financial stability is not an end goal in and of itself. Financial stability is a necessary precondition which allows the societies we serve to increase its living standards and prosperity. And as public authorities we exist for the general good of the societies we serve. But as the financial crisis has shown, we should not be myopic when it comes to this issue of prosperity. The prosperity we had created in the years before the financial crisis, had been based on excessive leverage. Our economies had seen too much credit growth, which was not adequately backed up by underlying strong economic and financial fundamentals of companies, households and even of governments. In short, the prosperity had turned out to not be sustainable. And so, as we updated our mission statement in 2011, we knew that the word prosperity had to be qualified with the word ‘sustainable’. At first, our main thinking was in relation to the economic and financial crisis. Sustainable prosperity meant, for example, that banks should have sufficient buffers to absorb unexpected losses. But it soon became clear that the word sustainable, daily bread and butter stuff I would almost say, could have broader implications. If the way in which prosperity is created today results in significant ecological damage that prevents future generations from obtaining similar or higher levels of prosperity, today’s prosperity creation is not sustainable either, and runs thereby counter to our mission. And this is at the core of today’s topic. We are almost all supervisors here. We all have an obligation to ensure that the institutions we supervise are able to meet their contractual obligations. Now and in the future. Our pension funds and insurance companies will still need to be able to pay out their obligations 50 years from now. While we also want our banks to be safe for decades to come. This means that we and the institutions we supervise need to take long term trends and risks into account. And that means paying attention to climate risks. Because couldn’t it be feasible that climate change or the energy transition could have an effect on the solidity and integrity of financial institutions or the financial system as a whole? We think yes. And this is why we have been active on this issue. And this is why we are one of the founding members of this Network. And this is why we are hosting you here today. Ladies and gentlemen, It’s an honor to be the host of not only the first ever conference on climate risks and supervision, but also the first ever conference of the Central Banks and Supervisors Network for Greening the Financial System. We hope and are convinced it won’t be the last. | netherlands bank | 2,018 | 5 |
Closing remarks by Mr Frank Elderson, Executive Director of the Netherlands Bank, at the first International Climate Risk Conference for Supervisors, Amsterdam, 6 April 2018. | “Let the future of finance be that of financing the future!” With Mark Carney’s speech, we have come to an end to today’s conference. Before we move on to the much deserved reception with drinks and snacks, please allow me to share a few closing thoughts with you. I would first of all like to thank the ACPR and Bank of England for co-organizing this event with us. Without their commitment and hard work, we would have never such an impressive line-up of speakers: more than 35 different speakers, moderators and panelists! I want to thank in particular the organizing committee, consisting of representatives of our three organizations for all their hard work. And I want to thank you all for coming here, from all corners of the globe. We hope, as do all NGFS members, that this conference has inspired you. And that you will go home motivated to take the next steps for integrating green finance into supervisory practices. And if you get back home, and you want to get to work, but you are also unsure how to start: know that the NGFS is open for business and that we very much welcome applications from those willing to enthusiastically contribute to the work of the NGFS. And let me just say this though: Sustainability is not some niche. It’s is not a "nice to have" for the happy few. Sustainability is crucial for our own survival. There is no alternative. Without rendering our way of life sustainable, we die. In fact, people are dying already. The World Health organization states on its website that “Climatic changes already are estimated to cause over 150,000 deaths annually.” And the site provides us with direct links to scientific studies on this subject. So as long as we keep speaking about sustainable finance we will not have succeeded. We do not need a thing called ‘sustainable finance’. We need all finance to be sustainable. This is our ultimate to-be-or-not-to-be moment. Finance will be sustainable or there will be no finance. We as a regulatory community, we as the central banks and prudential supervisors of the world, have a crucial role to play in all of this. A role squarely within our mandate as supervisors and financial stability authorities. We must contribute to this Great Financial Transformation by ensuring the safety and soundness of financial institutions and the system as a whole in this transformational process. The good news is that we have already come a long way, as is evidenced today by all the examples we’ve heard, by all the institutions present, and by all the inspiring speakers and participants. And once we have reached that goal of all finance being sustainable, we will have ensured a better horizon for our children and their children. A horizon - a future! - that to our children is not tragic, but positive and bright. We will have overcome the tragedy of the horizon. That “the last syllable of recorded time” be not the word “tragedy”. So let us together ensure that horizons from this day will no longer be associated with tragedy, but instead with a bright, green, sustainable future. Let the future of finance be that of financing the future! Thank you. | netherlands bank | 2,018 | 5 |
Introduction speech by Mr Klaas Knot, President of the Netherlands Bank, at the DNB High-Level Seminar, Amsterdam, 24 May 2018. | “Hot Property: the housing market in major cities” Introduction speech by Klaas Knot at the DNB High-Level Seminar Amsterdam, 24 May In his opening speech at the DNB housing market seminar, Klaas Knot shares his view on how housing prices can become a problem for broader economic wellbeing, and thus form an area of interest to central bankers. A more balanced and suitable supply of housing is needed. The new Dutch housing agenda is a promising example of the leading role our government should play on the Dutch housing market. Distinguished guests, Welcome to Amsterdam! The city with the highest house price rises in the Netherlands and, last year, also in the Eurozone. I live here, so I have witnessed the soaring prices at first hand. Amsterdam, like many capital cities, has led the rebound in the Dutch housing market, which started in 2013. Prices here began to take off, and within a few years were growing at annual rates of over 15%. It is the same story in other large cities in the Netherlands. And more recently, the rest of the country has followed this trend, so house prices are rising everywhere. My work takes me all over the globe, to the world’s major cities. Many of you come from these cities, in Europe: London, Paris and Stockholm, but also Washington, Seoul and Sydney. And similarly, I have seen with my own eyes similar housing market dynamics in these locations, as they are becoming increasingly popular. This is why we invited you all here, to discuss some serious questions. Do we agree on the analysis of the problems in this field? Could we learn from each other’s best practices? Is there one solution? My view But first, please allow me to share my view. As a resident, as the president and of course as an economist. While the increased popularity of cities worldwide may be good news for these places, and for homeowners, it also poses challenges. Demand for urban housing is strongly outstripping supply. This leads to the surge in housing prices that we are seeing. At the same time, it also puts pressure on rental markets. And although supervisors, central banks and governments have strengthened mortgage regulation since the crisis, the risk of a credit-driven boom always looms. After all, homeowners are often willing to take on more debt to be able to live in the city. We haven’t yet seen a credit boom in the Netherlands, but in some other countries house price growth is coupled with strong mortgage growth. Indeed, the strong price increases are making urban housing affordability a pressing issue everywhere in the world. For central bankers, responsible for financial stability, affordability may not always be their most important concern. However, extreme examples such as the San Francisco Bay Area, Silicon Valley, where the average house costs €1.5 million, show this can become a problem for broader economic wellbeing. As these areas are booming, many workers cannot afford to live there anymore. Recently, we see books, research papers and newspaper articles documenting these consequences of decreasing affordability, social as well as economic. Urban demographics are changing as a result. Young, well-educated people are drawn to cities, often chasing a limited supply of housing. Due to the housing shortage, middle-income households are at a disadvantage: too rich to qualify for social housing, not rich enough to buy a house. They need to rely on the rental market. However, if this market does not function well, as is the case in many cities, middle income families are forced to move away. Moreover, the rise of major cities also leads to increasing divergence between these cities and more peripheral regions. At the same time, spillover effects cause prices to rise in areas directly bordering major cities. This ultimately affects the structure of economic development, which increasingly shifts to urban areas and away from the periphery. Housing supply The lack of suitable housing plays a major role here. Supply shortages in cities, and to a lesser extent in other parts of the country, are a main driver of current price rises. And as we know from past experience, strong house price rises can lead to overshooting. Which is often followed by a correction. This price volatility does not remain confined to the housing market. In countries like the Netherlands, with a high rate of home ownership and dependence on mortgage lending, house price volatility feeds into the real economy. The link between house prices and private consumption is very strong here. This symbiotic relationship causes booms to grow larger and busts to be deeper. A more balanced and suitable supply of housing is thus needed. This does not only mean owner-occupied housing, but also private rental, especially for middle-income households. As a DNB study pinpointed last year, they are put in a tight spot on the housing market. In our view, a larger mid-market private rental segment is the key to creating a housing market that is free of such imbalances, especially in cities. On top of that, it will make the housing market better aligned to the needs of the increasingly flexible and globalized labour market. However, since last year, the necessary progress on enlarging housing supply is still limited. A lack of planning and building capacity, as well as zoning restrictions, are impeding new-build developments in and around cities. Moreover, lower-tier governments like municipalities lack effective incentives to develop the private rental sector. So it is up to the Dutch government to take a more pro-active, leading role in ensuring an appropriate supply of new houses. They have the means to encourage municipalities to provide more private rental housing, for instance by setting minimum targets. In practice, this would mean that the government makes arrangements with municipalities about including a minimum percentage of mid-market rental housing in zoning plans. Moreover, as a higher-level body, the national government can coordinate between localities and is less affected by local pressures, such as NIMBY (Not-In-My-Backyard) protests. Therefore, I was very happy to hear, yesterday, the Minister of the Interior presenting a new housing agenda. This agenda is meant as an accelerator to ensure the construction of 75,000 new houses each year until 2025. I think this is good initiative, all the more because a broad spectrum of housing market stakeholders is involved: builders, housing associations, home-owners, institutional investors and local governments. To me, this is a promising example of the leading role our government should play on the Dutch housing market. Our next speaker, whom I will introduce shortly, will speak more about the Dutch government’s efforts in this field. As a central banker with a financial stability mandate, these housing market developments pose new challenges for risk analysis and possible policy responses. And I am sure you are all struggling with these challenges too. Today’s and tomorrow’s seminar You are now all here in this room to discuss these issues under the watchful eye of our past presidents. And as you might have noticed from the programme, not only do you come from different countries, but also from divergent backgrounds. When organising this seminar, we wanted to avoid groupthink and promote a healthy exchange of views from different perspectives. So some speakers come from central banks and public bodies, others from academia or the private sector. And of course a seminar about major cities would not be complete without representatives from cities themselves. We hope your different backgrounds help us tackle the questions that are facing us. Today and tomorrow, we would like to address four of these questions. We start with the question of why big cities are so popular, and whether this popularity is here to stay. The first session will be devoted to this question. But I am also sure our keynote speaker professor Edward Glaeser will shine more light on this issue. After all, he has been conducting research on urban development for over 25 years. Being at a central bank, we will also broach the bubble question: is there a housing bubble in the big cities and how do you measure this? If there is anything the financial crisis has taught us, it is that there is most cause for concern when this bubble is fuelled by excessive credit provision. Credit-driven bubbles are most detrimental to financial stability. Curiously, in the Netherlands, the housing market recovery does not seem to be credit-driven: house prices seem to be exploding, but mortgage growth is near zero. I cannot help but notice that this uncommon development is driven by today’s low interest rates. As private investors do not find sufficient return in savings accounts or other safe investments, they turn to the housing market which drives up prices. Tomorrow, we will then look at the third question, on the supply side of the housing market: what role do supply frictions play in the current environment? Cities are notoriously dense, and expanding supply is thus difficult in urban areas. So more than in peripheral areas, supply issues and policy options should be studied in detail. This brings us to the last topic, our fourth question: which policy actions are needed to effectively address these issues? Until recently, policymakers, at least at central banks, focused mainly on restricting demand. Measures like LTV limits, LTI restrictions and capital requirements should keep mortgage growth, and thus price growth, in check. However, current developments seem less driven by credit, at least in the Netherlands, and more by fundamentals like population growth and supply shortages. It’s thus likely we need to look further than our standard housing market toolkit. The seminar: proceedings & logistics To ensure the lessons learned today and tomorrow are available for the future, we will publish a conference proceedings after the summer. From the contributions we have already received, I can tell that this will be a rich collection of papers that will surely add to collective knowledge on urban housing markets. Before I introduce the next speaker, I would like to give you a few details on the logistics of the seminar. To begin with, each session has a different moderator. They have an important role today: to make sure presentations are kept brief and to-the-point, and to stimulate debate. Second, we are fortunate to have an impressive turnout of high-level policy makers, leading academics and financial sector representatives from various countries. Given the seating constraints, a number have to sit in the second row. At the same time, let me stress that everyone in the second row is just as welcome to participate in the discussion as those seated at the front. Finally, please note that we’ve invited a couple of our trusted friends from the Dutch press to attend this seminar. But, obviously, the Chatham House Rule applies, starting right after this introduction and the key note speech. So, nothing stands in the way of an open, thought-provoking and stimulating discussion! I sincerely hope that today’s seminar will bring our collective understanding of urban housing markets a bit further, and help us tackle the challenges ahead. And let me now turn to our next speaker. We had invited our Deputy Prime Minister, and Minister of the Interior and Kingdom Relations, Kajsa Ollongren. She is responsible for housing policy in the Netherlands. Unfortunately, and perhaps ironically, she has been called to The Hague for a parliamentary debate on the affordability of Dutch housing. In her stead, Erik-Jan van Kempen will deliver the opening remarks. ErikJan is Program Director General at the Ministry, responsible for implementing the Environmental and Planning Act. Moreover, as an inhabitant of Amsterdam, he is very familiar with the situation in the capital. He will now enlighten us with his view on these matters. Erik-Jan, the floor is yours. | netherlands bank | 2,018 | 6 |
Keynote speech by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, at the Global Capital Sustainable & Responsible Markets Forum 2018, Amsterdam, 4 September 2018. | “Let’s dance” Keynote speech Frank Elderson At the Global Capital Sustainable & Responsible Markets Forum 4 September 2018 At his keynote speech at the Global Capital Sustainable & Responsible Markets Forum, Frank Elderson shed his light on the ways central banks are contributing to the greening of the financial system. I understand you have already had a very interesting morning. You have discussed a broad spectrum of climate-related topics. From the plastic polluting our oceans, to the nitty-gritty of the EU’s sustainable finance taxonomy. It is a great pleasure to join today’s forum, which brings together market participants seeking solutions for greening their portfolios. But we are also here in a wider context, to support the Sustainable Development goals. It is a pleasure to be here in my capacity as chair of the NGFS. I noticed in the program a very small mistake. I don’t mean to be a nitpicker, but the acronym NGFS is explained there as ‘The Network ON Greening the Financial system’. I would like to be very precise here and highlight that we do not just aspire to be a network that merely speaks about a green economy… Or shares opinions on this. We aim to provide added value, and to actively support the creation of green markets. More so, it is our ambition to facilitate that the entire financial system can become green. Therefore, a Network FOR greening the financial system. Today you will get an insight into our work and progress. And I will describe how our activities fit within the broader context of international developments in this area. This should also give you, the private sector, a preview of what to expect in terms of regulation and supervision. I believe a stable and predictable regulator benefits everyone. But before I describe what we do and how we do it, let me first take you back to the WHY. Role central banks I don’t need to tell you that we face a climate problem. You all know that at the end of 2015 the international community came together to sign the Paris climate deal. It is clear we have to be greener. Clearer still is that this must be a joint effort. Globally. Across all sectors and segments of society. It’s not just up to the end consumer to pick green energy over brown, or the utility company to provide green energy. Or the bank to finance the green utility company. It needs a concerted effort from all parties. But bringing about a green transformation requires enormous investment. And that means the financial sector – which is you, my friends! - has a crucial role in channeling its resources towards a green and sustainable economy. And that is why there is an overwhelming case for supervisors and central banks to respond to environmental challenges. From the perspective of both risk and opportunity. Let me address the risk side first. Because as a supervisory authority, we tend to focus on risks. We are very sensitive to all types of risks to the stability of financial institutions, or to the system as a whole. So we also need to look at climate-related risks: we must assess how the physical effects of changing climate, like extreme weather events, can translate into financial risks for the institutions we supervise. The same goes for risks that can arise from the transition to a low carbon economy. This transition may lead to stranded assets and policy risks, which in turn can mean financial risks for the institutions we supervise. We aim to identify these risks. And where possible to manage, resolve or even mitigate them. And then there is the opportunity side. We supervisors do see sunny sides too, you know. Or at least we try to. I believe we must fulfill our responsibilities. As a supervisor, together with the financial sector, we must align our financial system with the sustainability goals. And we must support opportunities for green and sustainable finance. Of course, as a central bank and supervisor, we must not overstretch our mandate. But safeguarding sustainable prosperity falls well within our mission. This not only means financial institutions should have sufficient buffers to absorb unexpected losses. We also have to reexamine our current methods for creating prosperity. If these cause significant ecological damage, preventing future generations from obtaining similar or higher levels of prosperity, then how we create prosperity today is not sustainable either. This runs counter to our mission. There are ways we can impact investment decisions and credit allocation. Our supervisory policies could, for instance, take into account the transition to a low carbon economy. That’s why we as a central bank can help transform the financial infrastructure, so it facilitates the necessary flow of capital to where it is needed most. To help transform our economy into a low carbon one. We should remove all unnecessary obstacles to this transition. And assist the sector in creating common definitions and standards. As well as provide the necessary guidance. The development of a sustainable taxonomy is a good example of this. I know, this is not a conventional area of focus for a central bank. So, like the private sector, we are developing new tools and methodologies to support us in this goal. And guess what! We are not the only central bank or supervisor exploring this new type of risk. Central banks and supervisors worldwide are studying these issues. Of course, there are trailblazers: You’re probably all aware of the Bank of England’s pioneering work in this area. And this morning you discussed the EU taxonomy, which would take probably some time to enter into force. This is completely understandable for such a complex task. In this regard it is worthwhile to look at the Chinese approach for laying the foundation for green finance. They managed to develop a green taxonomy in just over two months! A remarkably short period of time. These are a couple of examples of countries that are ahead of the curve. At the other end of the spectrum are central banks, for which these issues are completely new to the agenda. Background and membership of NGFS These developments laid the foundation for setting up the network of central bank and supervisors at the end of last year, the NGFS. (You remember, the network for greening the financial system…). It brings together institutions that are determined to move forward on green finance and climate-related risks. Within the network we share experiences and best practices. This means we don’t all have to reinvent the wheel and are able to join forces. Since its launch in December 2017, the NGFS has experienced a rapid growth in terms of new members and observers. There were eight founding countries to begin with. But as chair I am proud to say we now have seventeen members and five observers. Hopefully, there are many more to come. And our members come from across the globe. It is not just a European party. No. All continents are represented. China, Singapore and Mexico were three of the founding members, as well as for example France and the UK. This summer, the ECB, including the SSM, the Single Supervisory Mechanism, came on board. I expect this to have a major effect within Europe. The SSM directly supervises all one hundred and nineteen significant banks in the euro area and also indirectly supervises the less significant banks in this area. That means all countries in the banking union are indirectly linked to the NGFS. Members demonstrate a strong collective commitment to the greening of the financial system. They are taking up their responsibility to contribute to the implementation of the Paris Agreement. Now you might be thinking, what do we actually do? What impact are we trying to achieve? Activities NGFS members voluntarily exchange valuable experiences and best practices on climate risk analysis and mitigation tools. These activities are structured around three workflows: microprudential supervision; macrofinancial issues; and scaling up green finance. In terms of microprudential supervision, we study and identify best practices of central banks and supervisors in analyzing climate-related risks affecting individual institutions. We map current supervisory practices for integrating environmental risks into micro-prudential supervision. This forces individual institutions to consider the impacts on their balance sheet. We also review current practices on environmental and climate information disclosure by financial institutions so we can identify best practices. Secondly, we attempt to quantify the physical and transition risk at a macroeconomic level. Here, we will identify examples of good practices by NGFS members. These include for example macro stress tests or scenario analyses. Our last area of focus is the role of central banks in scaling up green finance. We discuss current practices for incorporating ESG criteria in all areas of central bank operational activities. Against this backdrop, the NGFS will organize the seminar ‘Sustainable & Responsible Investment for central banks’. The event will be hosted here at DNB, on the 21st of September. Then, we will discuss best practices and principles for integrating sustainability considerations into management of official reserves. Concrete examples This might still sound a bit abstract in terms of what it could mean for you, for the financial sector. So let me return to the first area of activity: how can supervisors integrate climate risk into supervision? Last year, DNB examined the exposures of financial institutions to carbon intensive sectors. We published our findings in a report titled ‘Waterproof’. This gave us a good indication of the vulnerabilities in a hard transition scenario. We also looked at how new types of national policy could cause financial risks to materialize already in the shorter term. A good example of this is in the Dutch commercial real estate sector. In the Netherlands, as of 2023, all office buildings will have to meet minimum energy efficiency requirements, or face closure. In 2017, it was estimated that half the offices in the Netherlands did not meet this requirement. This raises the prospect of write-offs for lenders. As I said, I strongly believe in predictable, transparent public institutions. This example shows how new policies to achieve our Dutch carbon emission goals require transparent implementation, to avoid sudden shocks. Annual data requests, as part of our supervision, could give greater insight into the size and nature of the risk. This can form the basis for supervisors to engage in dialogue with institutions. We may then expect them to prepare a strategy for integrating ESG risks in their short and longer term risk analyses. To explain how they can adapt their investment strategy to align with the Paris ambition. And to demonstrate they have a clear view on the viability of their business model in a two degree scenario. In contrast to a supervisory dialogues, the one thing I believe we must not do, is to create wrong incentives. There are also advocates for changing capital requirements. To discourage brown exposures, or encourage green investments. However, we at DNB believe that capital requirements must essentially safeguard financial solidity and stability. Hence, without conclusive evidence that green exposures are less risky than other exposures, lowering capital requirements by introducing a green supporting factor will only increase the risks to financial stability. With evidence, the situation would change dramatically… We are not there yet. We need to work harder to determine the risk in “green”, but also in “brown” exposures. And to identify whether there exists any risk exposure differential between green and brown assets. This also is one of our focal areas in the NGFS. We can draw on the experience of all our members. And arrive at a common view. Also to safeguard a level playing field across prudential jurisdictions. Timelines NGFS Standing here now, I must say I’m very proud of the network’s progress. Ten months ago, the acronym NGFS still sounded odd. But today, we are right back on track and more and more countries are queuing up to board the train. It may run on only partly renewable sources at the moment, but hopefully in the near future it will be fully powered by certified green energy! And you will be able to assess the extent to which we succeed. The analysis conducted in the work streams will feed into a NGFS report to be issued in the first half of 2019. The final purpose is to define and develop best practices and promote these such so they will be implemented within and outside of the membership of the NGFS. Conclusion NGFS and DNB need to demonstrate they can support, underpin and promote the transition to a green financial system, as part of their regular mandate. And while our research on a possible future supervisory framework will continue, we’re excited by the initiatives that you, the private sector, have taken to model the risks and transform the financial markets. I believe you can drive innovation and might even be able to provide a more significant lever to advance global change. However, at a time of rapid change it is also important to analyse innovation within the public sector so as not to create new risks. So therefore, we hope to continue our dialogue and work on this challenge together. Or, in other words, as we are now in the ‘Grand Ballroom’ of the Okura hotel: Together, let us face the music and dance. Let’s dance together! Thank you. | netherlands bank | 2,018 | 9 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Peterson Institute for International Economics, Washington DC, 24 September 2018. | “Easy Money, Uneasy Finance” On the relationship between monetary policy and financial stability Speech by Klaas Knot at the Peterson Institute for International Economics Washington, 24 September 2018 In his speech at the Peterson Institute in Washington, Klaas Knot states that a sound financial system makes life much easier for central bankers. But the reverse is also true: a weak financial system can cost monetary policymakers many sleepless nights. And secondly, he points out the need for further improvements in the regulatory framework in the coming years. 1. Introduction Ten years ago, the global financial system was on the brink of collapse. Within just a couple of weeks, well-known and systemically important financial institutions either failed or teetered on the abyss. Activity in several key financial markets ground to a complete halt. Soon after, the global economy would enter a very deep recession. To remind you of the extreme circumstances of that time, let me show you the front page of the Financial Times from ten years ago on 24 September 2008. The headlines were dominated by the frenzied efforts of the US government and the Fed to deal with the fallout from the Lehman Brothers collapse. We all remember the unimaginable developments that happened in those weeks. And we all remember the pain of the Great Recession that hit the global economy in the following years. However, I also remember the global commitment and co-operation among policymakers. Deep uncertainty was plaguing the authorities. But a combination of extraordinary measures, including interventions, capital support and liquidity injections, eventually succeeded in restoring financial stability.1 And an unprecedented monetary stimulus was provided through a range of conventional and unconventional tools. Ten years later, we now stand at a vital crossroads. The supervisory reform program has made important progress. Monetary policies are now being normalized. This afternoon I want to take stock of the current challenges. I would particularly like to focus on the importance of a robust financial system for conducting monetary policy. I want to convey two main messages. First, a sound financial system makes life much easier for central bankers. It limits the effects of financial shocks on the real economy; it strengthens monetary transmission channels; and it reduces unintended consequences of monetary policy actions. But the reverse is also true: a weak financial system can cost monetary policymakers many sleepless nights. Second, against the background of a monetary environment that is likely to remain accommodative for some time, we therefore need to further strengthen the global financial system. And to do that, we need to further improve the regulatory framework in the coming years. I will argue that the financial system is in much better shape than a decade ago, but important risks still remain. I will argue that international regulatory authorities firstly need to maintain strict micro- and macroprudential regulation; secondly, must seek further improvements in policy implementation; and thirdly, should adapt to risks shifted outside their perimeter. 2. Causes of the crisis and policy responses Let me briefly recall the financial, economic and policy circumstances which allowed the global financial crisis to develop. Causes of the crisis In the decades before the crisis, the global financial system changed profoundly. This was the result of deregulation, increasing competitive pressures on banks and increasing financial globalization. These trends have led to a greater role for market finance and a stronger interconnectedness within the financial system. During the same period, the macroeconomic environment underwent important structural changes. This happened on the back of accelerating globalization, the emergence of new players like China, and technological progress. Against this background, large global flows of savings and investments 1 See B. Bernanke (2009). Reflections on a Year of Crisis. Speech at the Federal Reserve Bank of Kansas City's Annual Economic Symposium, Jackson Hole, Wyoming. 21 August. The same remarks were delivered at the Brookings Institution, on 15 September 2009. pushed down long-term interest rates, in the United States and other advanced economies.2 Accommodative monetary policies further allowed for financial risk-taking. It has been argued that the “Great Moderation” allowed a leverage build-up that ultimately threatened financial stability and hence macroeconomic stability.3 In the regulatory policy sphere, a widespread trend towards deregulation loosened the reins on risk-taking in the financial sector. Microprudential supervision was not well equipped to address this increased risk-taking. In addition, macroprudential orientation of regulatory policy addressing systemic risk was almost completely absent at that time. In this environment, misaligned incentives prompted widespread risk-taking in the financial system. In combination with high economic growth, important imbalances developed. When the crisis erupted, banks did not have sufficient capital to absorb losses and authorities were not adequately prepared to handle failing banks. The imbalances spread almost instantaneously across the global financial system, as a result of the interconnectedness of financial institutions and markets. These patterns are not specific to the global financial crisis, as economic historians have documented.4 Typically, financial crises are preceded by booms where factors like high growth, innovation and increased risk taking interact. In a very recent paper Ben Bernanke introduces yet another element: the excessive reliance of financial institutions on short-term wholesale funding.5 This new element explains why the global financial crisis was more extreme, and why it had more severe effects on the real economy. Policy responses When the crisis erupted we needed new policy toolkits. In the last ten years, therefore, a comprehensive reform program has been developed, under the leadership of the G20, the Financial Stability Board, and the Basel Committee of Banking Supervision. The reforms have made financial institutions better equipped to deal with future shocks. Thanks to these reforms, banks hold significantly more capital, which is more readily and easily available to absorb losses. Banks also have stronger liquidity positions and have strengthened their governance and risk management. Prudential policies increasingly include a macroprudential orientation with a 2 For a recent analysis of this mechanism, see B. Bernanke (2015) Why are interest rates so low, part 3: The global savings glut. Wednesday. Brookings Blog, 1 April 2015. 3 See e.g. G. Stevens (2012) Challenges for central banking. Address to the Bank of Thailand’s 70th Anniversary and 3rd Policy Forum, Bangkok, 12 December; C. Borio (2014) Monetary policy and financial stability: what role in prevention and recovery? BIS Working Papers No 440. 4 See e.g. Ò. Jordà, M. Schularick, A.M. Taylor and F. Ward (2018) Global Financial Cycles and Risk Premiums. NBER Working Paper No. 24677. For an analysis of these elements in the first financial crisis of the modern era, see R. Frehen, W. Goetzmann, and G. Rouwenhorst. (2009) New Evidence on the First Financial Bubble. NBER Working Paper No. 15332. 5 B. Bernanke (2018) The real effects of the financial crisis. BPEA Conference Draft, Fall. stronger focus on financial stability. Risks originating in the shadow banking sector are better appreciated, and over-the-counter markets have become more robust and transparent. In addition, resolution management has emerged as a new toolkit to reduce too-big-to-fail distortions. And it became clear that traditional monetary policy responses were not sufficient to deal with the Great Recession. As policy rates were cut to their effective lower bound, further monetary accommodation was achieved through unconventional tools such as forward guidance, longer-term refinancing operations and asset purchases. With the help of these new tools, monetary policy contributed to fixing a dysfunctional monetary transmission mechanism, supporting the recovery and averting deflation risk.6 3. A framework for assessing monetary policy and financial stability Today, the financial system is more resilient and the global economy is enjoying a period of strong economic growth. However, important challenges remain for both monetary and regulatory policymakers. A framework I consider very useful for guiding policy actions is based on the following three key elements7: Firstly, the necessity of policies. Do circumstances require action by authorities? Secondly, the effectiveness of the instrument. Can the proposed policies achieve the intended objectives? And thirdly, the possible unintended consequences of interventions. In my view, both monetary and regulatory policies need to be based on such criteria as guideposts for policymaking. 4. Financial stability and the monetary policy triangle Let me apply this framework to monetary policy first, and focus on the interplay with financial stability. My main point here is that a sound financial system makes life easier for monetary policymakers. Let me elaborate. 6 See e.g. J. Yellen (2017). The Goals of Monetary Policy and How We Pursue Them. Remarks at the Commonwealth Club, San Francisco, California, 18 January; M. Draghi (2017). Accompanying the economic recovery. Introductory speech at the ECB Forum on Central Banking, Sintra, 27 June; K. Knot (2017) Modesty in times of uncertainty. Speech at the Business Economists’ Annual Dinner, London, 29 November 2017. 7 For a lucid analysis along these lines, see W. Dudley (2013) Why Financial Stability is a Necessary Prerequisite for an Effective Monetary Policy. Remarks at the Andrew Crockett Memorial Lecture, Bank for International Settlements 2013 Annual General Meeting, Basel, Switzerland, 23 June 2013. Necessity First, a sound and stable financial system will reduce the need for monetary policy actions aimed at macroeconomic stabilization. The global financial crisis and the ensuing Great Recession have shown that shocks emanating from the financial system can have a devastating impact on the real economy. Similarly, a financial system experiencing stress amplifies the effect of shocks originating in the real economy. Both mechanisms then lead to larger deviations of output from potential, and inflation from target, compared to an environment in which the financial system had remained stable. In turn, this would call for more monetary policy interventions to stabilize output and inflation. Effectiveness Second, monetary policy is more effective when the financial system is sound. Standard monetary policy determines marginal financing conditions in the short-term money market. Its macroeconomic effects depend on several channels through which financial intermediaries pass on these policy rate decisions to the real economy. Especially on my side of the Atlantic, during the European debt crisis, these transmission channels became impaired.8 This severely restricted the ability of policy rate cuts that central banks had implemented to stabilize the real economy. Central banks ultimately had to resort to unconventional monetary policy tools, to restore the pass-through of lower policy rates to firms and households.9 A sound financial sector therefore enhances the effectiveness of monetary policy by improving the functioning of the monetary transmission mechanism. It helps monetary policy achieve its objectives with less effort, and reduces the likelihood that the effective lower bound is reached. Unintended consequences Third, the more sound a financial system, the less likely it is that monetary policy will have unintended consequences. Conversely, the weaker a financial system, the more likely it is that monetary policy actions will create unintended consequences. 8 A recent research paper by DNB economists illustrates this mechanism and shows that recapitalizing banks more quickly (as it was done e.g. in the United States) strengthens the monetary transmission mechanism (M. Mink and S. Pool (2018) Credit supply and monetary transmission after a banking crisis. Mimeo, DNB). 9 For an early theoretical analysis of this mechanism, see e.g. V. Cúrdia and M. Woodford (2011) The central-bank balance sheet as an instrument of monetary policy. Journal of Monetary Economics, 58 (1). An overview of theoretical and empirical research on how the GFC was transmitted to the real sector, the nature of financial frictions and their impact on the transmission of monetary policy decisions can be found in M. Gertler and S. Gilchrist (2018). What Happened: Financial Factors in the Great Recession, Journal of Economic Perspectives, 32(3). These unintended consequences of monetary policy for financial stability can occur through different channels. A first and much debated mechanism is the risk-taking channel of monetary transmission. According to this, monetary policy has a systematic impact on ex-ante risk-taking in the financial sector, by setting the universal price of leverage10, affecting financial conditions and ultimately the real economy.11 A prolonged period of loose monetary policy can contribute to the build-up of financial imbalances. In this sense, persistently low interest rates since the turn of the century have been perceived as contributing to the global financial crisis as well.12 A second mechanism through which persistently low rates affect financial soundness relates to the reduced incentives for balance sheet repair. The more so if macro- and microprudential regulation are insufficiently developed.13 This is most evident in a crisis situation, such as the one from which we have recently emerged in the euro area, or the crisis in Japan in the 1990s. Monetary stimulus through conventional and unconventional instruments, may help to avoid a collapse of the banking sector. But it can come at the expense of reduced incentives for balance sheet repair by individual banks. It can promote the evergreening of non-performing loans and even regulatory forbearance. In this context, unconventional policy instruments are more intrusive than conventional monetary policy. And they can create deeper market distortions that aggravate the risk of a misallocation of resources and financial instability. It is often argued that prudential and not monetary policies should be geared towards financial stability risks. But I tend to agree with Charles Bean that “there are important qualifications to this somewhat Panglossian view of the ability to maintain both price stability and financial stability by assigning monetary policy to the former and macroprudential policy to the latter.” 14 10 See C. Borio and M. Drehmann (2011) Financial instability and macroeconomics: bridging the Gulf. Financial instability and macroeconomics: bridging the gulf. In A, Demigüç-Kunt, D. Evanoff and G. Kaufman (eds.) The international financial crisis: Have the rules of finance changed?, Singapore: World Scientific Publishing. 11 See Borio, C., and H. Zhu (2012). Capital Regulation, Risk-Taking and Monetary Policy: A Missing Link in the Transmission Mechanism. Journal of Financial Stability; F. Smets (2014) Financial stability and monetary policy: How closely interlinked?https://www.ijcb.org/journal/ijcb14q2a11.htm International Journal of Central Banking. 12 For an analysis of the role of low short-term interest rates in the GFC through their impact on risk-taking incentives, see J. Stein (2013) Overheating in Credit Markets: Origins, Measurement, and Policy Responses. Speech at the Federal Reserve Bank of St. Louis research symposium on “Restoring Household Financial Stability after the Great Recession: Why Household Balance Sheets Matter”, 7 February. For a careful discussion of the channels through which a low-for-long scenario could still engender material risks to financial stability, see Committee on the Global Financial System (2018) Financial stability implications of a prolonged period of low interest rates. CGFS Papers No 61. 13 The idea that low capitalization can induce risk shifting in response to shocks hitting bank balance sheets was developed in a seminal study by M. Dewatripont and J. Tirole (1994) The Prudential Regulation of Banks, MIT Press. See also J. Tirole (1994) On Banking and Intermediation. Joseph Schumpeter Lecture. European Economic Review. 14 C. Bean (2014). The future of monetary policy. Speech at the London School of Economics, London, 20 May 2014. This implies that an effective prudential policy is a necessary but not a sufficient condition for monetary policy to be effective in the medium to long run. Central banks must be conscious of unintended consequences of a monetary strategy that keeps policy rates low for a long time. Translating this to the current context, my main takeaway is that as long as inflation remains subdued, central banks are likely to maintain an ample degree of monetary accommodation. But the longer this accommodation is maintained, the more pressure will mount on financial regulators and supervisors to be able to preserve financial stability. 5. Financial stability and the regulatory policy triangle So what would this mean in practice, and how does it relate to the international regulatory agenda? My key point here is that in an environment in which monetary policy is likely to remain accommodative for some time, it is important that the agenda for regulatory reforms is pushed ahead, along several dimensions. Let me also elaborate here by referring to the same three elements: necessity, effectiveness and possible unintended consequences. Necessity The first question is whether the regulatory reforms that have been adopted are still necessary. My short answer here is Absolutely. And we actually need to strengthen our regulatory toolkit even further. As I mentioned before, the global financial crisis could develop in an environment with high growth and increasing risk appetite, with low interest rates and abundant liquidity on the one hand, and on the other hand the emergence of new risks, due to technological developments or innovation that were not adequately captured by microprudential and macroprudential regulation. The regulatory reforms taken in response to the crisis were thus needed to restore the balance in a previously under-regulated sector. As of today, vulnerabilities in bank intermediation are much smaller and bank resilience is stronger. However, some of the drivers of the crisis are still present.15 The total debt of households, firms and governments is now higher than ten years ago. Short and long-term rates are still very low. And financial institutions and markets remain strongly interconnected. 15 See e.g. H.S. Shin (2018) Reflections on the Lehman collapse, 10 years later. Translation of an article in the Frankfurter Allgemeine Zeitung, 15 September 2018. In this context, we should be wary of recent indications of diminishing momentum for regulation. And there are even industry calls for rolling back some of the agreed reforms, to which I clearly would not subscribe. On top of that, I would like to highlight the need to further develop the macroprudential toolkit. The current macroprudential tools are incomplete and – by design - limited in scope and impact.16 Almost all jurisdictions have established a macroprudential authority. But there is still some difficulty to identify – and/or reluctance to actively develop macroprudential policies to address risks to the financial system as a whole. Effectiveness The second question is whether the regulatory reforms carried out thus far were effective. Although the early signs of much stronger resilience in the core financial system are encouraging, it is still relatively early to judge whether this has been enough. Too-big-to-fail incentives have surely been reduced, but few would argue they have actually been eliminated. The new rules in response to the crisis were also designed in a short time frame and many reforms progressed in parallel. It is therefore a natural process that, after the initial implementation of such a comprehensive set of reforms, policymakers now shift their focus to the phase of policy evaluation. International standard setting bodies like the FSB have to continuously assess the design and implementation of reforms to see whether regulation meets the objectives while minimizing distortions. And this is what we are actually doing. It goes without saying that such analyses should be evidence rather than sentiment based, and focused on better rather than less regulation. The global financial crisis has also shown that international co-operation is key in developing effective regulatory policies. The global financial sector is closely integrated, and national or regional developments create external effects that directly and indirectly affect financial stability in other jurisdictions.17 Developing a common approach creates a level playing field between jurisdictions which prevents regulatory arbitrage. The post-crisis reform agenda, but also the creation of a single supervisory mechanism in Europe are important examples of successful international cooperation after the crisis. 16 E. Cerutti, S. Claessens and L. Laeven (2017) The use and effectiveness of macroprudential policies: New evidence. Journal of Financial Stability. 17 For a discussion of how regulatory arbitrage results from the increasing international integration of banking systems, see O. Jeanne and A. Korinek (2014) Macroprudential policy beyond banking regulation. Financial Stability Review, Banque de France, 18., Empirical evidence on this type of regulatory arbitrage is reviewed in G. Galati and R. Moessner (2018) What do we know about the effectiveness of macroprudential policy. Economica. Unintended consequences The third question relates to unintended consequences of regulatory reforms. A main concern here is the potential of shifting risks outside the regulated sector as new rules come in. As Charles Goodhart forcefully argued, prudential policy faces a “boundary problem”: …effective regulation can penalize financial intermediaries within the regulated sector compared to those just outside, leading to substitution flows towards the unregulated.18 For example, when it comes to what we now call non-bank financial intermediation (formerly known as shadow banking) the growth of total assets in recent years has been higher than in traditional banking. It is true that since the crisis, efforts by the G20 and the FSB have resulted in better insight into non-bank intermediation. Yet there are still important questions about potential systemic risks originating from the unregulated sector and how these risks could interact with those emanating from the regulated sectors. 6. Conclusion Let me conclude. The global financial crisis was a sobering experience that presented an existential threat to financial stability. The potential disruptive effects to the financial sector and the economy at large called for exceptional measures. In those turbulent times, the monetary, regulatory and supervisory response essentially followed three guideposts. Firstly, authorities did what was needed. Secondly, they implemented policies that were effective. And thirdly, they tried to mitigate unintended consequences. We have come a long way. Financial stability has been restored and the financial system is now more robust than a decade ago. However, the next ten years will undoubtedly present new challenges. History teaches that new vulnerabilities will emerge and the next financial crisis will eventually occur. We cannot assume that financial regulation will always be able to fully prevent the next crisis, because regulatory coverage is never complete and new risks can emerge from other segments of the economy or its financial sector. Technological innovation will continue to change the business models of banks and how they operate within the financial sector. New businesses will emerge along the chain of value creation. 18 C. Goodhart (2008) The boundary problem in financial regulation. National Institute Economic Review, 206; and M. Brunnermeier, A. Crockett, C. Goodhart, A. Persaud and H.S. Shin (2009) The fundamental principles of Financial Regulation. Geneva Reports on the World Economy, Centre for Economic Policy, London. One of the few studies that provides evidence on the substitution from bank-based financial intermediation to non-banking intermediation in response to macroprudential measures is J. Cizel, J. Frost, A. Houben an P. Wierts (2016) Effective macroprudential policy: Cross-sector substitution from price and quantity measures, IMF Working Paper No. 16/94. These fundamental changes can lead to disruptive innovation and new operational risks, such as cybercrime. Such risks are outside the natural domain of regulatory authorities, but will become increasingly important to financial stability. Financial supervisors should therefore continue to expand their knowledge and enhance their risk monitoring activities in those areas. This underlines why we have to remain vigilant and continue to adhere to our strategy of pursuing a sound financial system. It would support and enhance current monetary policies and contribute to containing the unintended consequences. In addition, a well-regulated financial sector would provide us with a much better starting point than prior to the global financial crisis. Little I said is entirely new – yet I feel that these words should now be heard again. Let me illustrate that with a 2001 quote from the late Andrew Crockett, whom we all know as one of the founding fathers of the FSB: “achieving the elusive twin goals of financial and monetary stability will require mutually reinforcing anchors to be put in place in the two spheres. Moreover, it will require an enhanced appreciation of the interdependence of policies in the two areas.”19 And perhaps, instead of everything I have said today, these words alone would have sufficed. 19 A. Crockett (2001) Monetary policy and financial stability. Speech at the Fourth HKMA Distinguished Lecture, held in. Hong Kong, 13 February. | netherlands bank | 2,018 | 10 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the EBF Conference "The Evolution of Power", Groningen, 5 October 2018. | “The evolution of power of Blockchain: a central banker’s balancing act” Speech by Klaas Knot at the EBF Conference The Evolution of Power, Groningen, 5 October 2018 In his speech at the EBF Conference The Evolution of Power, Klaas Knot shares the current thinking of De Nederlandsche Bank on blockchain and distributed ledger technology solutions, highlighting both the opportunities and the risks. Innovations like distributed ledger technology have potential in the financial system where there are some interesting and promising business. Yet, more widespread trading of cryptos may lead to reputational risks for financial institutions, and affect confidence. Introduction The title of this conference, ‘Evolution of power’, puts me in a somewhat awkward position. I am after all the president of a central bank. And the core concept of power in a blockchain is decentralization. Bitcoin, for instance, was created as a peer-to-peer network. So there would be no need for a central authority. In the words of Satoshi Nakamoto, the pseudonym of its founding father: “The problem [with a central authority solution], is that the fate of the entire money system depends on the company running the mint”. In this case, the mint is run by the institution that issues currency, in other words, the central bank. So, blockchain’s evolution of power is a development away from a regulatory authority, away from the central bank. You can understand that central bankers like myself are by nature skeptical about such a development. Focusing on risks, as we typically do, we ask critical questions: What are the flaws in the current system? What efficiencies do new technologies such as blockchain bring to the table? How should we cope with possible risks stemming from blockchain? The Dutch central bank keeps a close eye on developments in this field. And yes, we have been depicted in the media as being critical towards these innovations. But that’s not the full story. Innovations like distributed ledger technology have potential, also in the financial system. So today I want to share with you our current thinking on blockchain and DLT solutions, highlighting both the opportunities, and the risks. I will start with the opportunities blockchain could bring and its application in financial services. I will then turn to cryptos and their risks. Here, I will also touch on the regulatory response. Oh, and by the way, when you hear me say DLT, I mean distributed ledger technology… I’ll use the words DLT and blockchain interchangeably, not focusing too much on technical specifications. After all, if you want to dive into technicalities, then you should have gone to the parallel session by Microsoft… Potential for innovation through blockchain Let’s start with the good news. There are plenty of opportunities that new DLT technologies, such as blockchain, could bring in the not-so-distant future. More and more businesses today are testing DLT in different contexts. Diamond registration is an often-used example. And DLT may also offer benefits for the international trade like the coffee trade, in terms of traceability, logistics and supply chains. Increasingly, we see business cases popping up where blockchain could improve processes. In the financial system, blockchain is also making advances, albeit much slower. The sector’s strict requirements on efficiency and integrity may partly explain this. But as the technology advances, it could have a considerable impact on the financial system too. Blockchain could change securities depository and settlement systems. Some of these financial market infrastructures have already announced their intention to embrace DLT. The Australian Securities Exchange claims it will replace its clearing and settlement systems with a DLT-based solution. Focusing on development aid, our international colleagues at the World Bank in Washington see great potential for blockchain in emerging markets. And Her Royal Highness Queen Máxima, as the Special Advocate for Inclusive Finance at the United Nations, has underlined the possible benefits of new technologies such as blockchain for financial inclusion. And rightly so. In low-income countries, the financial infrastructure is often shallow. In these situations, DLT could greatly increase efficiency. Emerging markets also stand to benefit by lower remittance costs and higher financial inclusion for currently unbanked populations. The World Bank has recently made headlines by issuing a bond to international investors, completely based on blockchain technology. Large Dutch banks have also performed several experiments with blockchain technology, aimed at improving their payments systems and customer service. For instance, by supporting international trade and trade finance. Central bank experiments and blockchain in financial services So there are some interesting and promising business cases for blockchain. But challenges remain. These technologies will require substantial further development and testing before we see their more widespread use in the financial system. Central banks around the world are experimenting with DLT. They are seeking to identify the potential for its use in their payment systems, and the impact it will have on the financial system at large. Let me give you a few examples of these experiments: Under the name Project Jasper, the Bank of Canada has studied the use of DLT technology for various applications, including the clearing and settlement of high-value interbank payments. The ECB and Bank of Japan have set up Project Stella, currently in its second phase. They are exploring how DLT could be used in financial markets for the settlement of financial transactions, such as post-trade delivery of securities. We have also carried out experiments with blockchain technologies at the Dutch central bank. Over the past three years, we have developed and evaluated four prototypes under project Dukaton. Our aim was to gather knowledge and assess the usefulness of the technology in improving payments and securities transactions. We continue to invest in deepening our understanding of this technology, and in conducting experiments. We believe blockchain technology is interesting and promising. All these experiments by central banks – and there are many more – have led to a better understanding of DLT. This has helped us estimate the potential impact on our financial systems. The main conclusion is that while it is a promising technology with certain benefits, there are still considerable hurdles to overcome before it can be widely used in the financial system. Let’s look at some of the main findings: First, an interesting property of blockchain is that the software itself provides built-in resilience. Many central banks have concluded that blockchain could make payment systems safer, in terms of better resilience to cyberattacks and other disruptions. The network is less reliant on a central party, avoiding a single point of failure. Also, a consensus model would be better equipped to identify possible malicious insiders. An open question is still how to deliver on the resilience, while also improving functionality and efficiency. Secondly, DLT could also reduce settlement risks, as it offers an alternative method for delivery versus payment. Transactions can be settled within seconds, with full anonymity and confidentiality. Settlement risk is one of the major issues in post-trading financial systems: the risk that one party in a transaction fails to deliver on its end of the deal. Currently, settlement risk is mitigated by central counterparties. They administer and guarantee the delivery of securities by the seller on the one hand, and receipt of the selling price in cash on the other hand. Settlement in seconds, without the risk of the other party not delivering in time, could be a promising future. An often mentioned downside of using DLT in this context is settlement finality, which depending on how the blockchain is configured, cannot always be fully guaranteed. A third potential benefit is that blockchains can be designed so that the central bank or supervisor can see details of all transactions. This allows for regulatory supervision and oversight, which is needed for maintaining the high standards of integrity in the financial system. Finally, one of the greatest obstacles to using blockchain in the financial system is its efficiency. Banks and other firms process millions of transactions daily. But this is a major challenge for decentralized systems like DLT. Energy efficiency is still a problem too: there are estimates that the bitcoin mining network uses a a similar amount of energy as the whole of Ireland. Public blockchains that make use of other consensus models could more efficient. Also, a privately permissioned system, would greatly diminish energy consumption. But it seems very unlikely that blockchain will be able to process as many transactions as current systems do, at least not any time soon. Undoubtedly, some of the benefits of blockchain will only materialize when the technology has been developed further. When the system as a whole is more mature. There should be more real-life examples to test the resilience of blockchain applications. Certain financial firms have already taken the first steps. Central banks are experimenting with blockchain and are open to further advancements, while keeping a close eye on the possible risks. For the moment however, we can only conclude that blockchain hasn’t led to any groundbreaking changes in the payments ecosystem. From a financial system perspective, the ‘evolution of power’ has not yet occurred. On cryptos and their risks Blockchain’s most visible impact on the financial landscape has been the rapid rise of cryptos. This is a topic that deserves more attention. Let me first clarify that we, as the central banking community, tend not to use the term ‘cryptocurrencies’. The word ‘currency’ implies money. Our understanding of money is something completely different. It is based on the three functions of money – as a means of payment, store of value, and unit of account. Even bitcoin, the most widely-recognised crypto, doesn’t fulfill these functions. It’s difficult to pay with it in a store, its value is undermined by its volatility, and it has no use as a unit of account. As it doesn’t meet these three criteria, we prefer to use the term crypto-asset or simply, crypto. Cryptos could represent opportunities as well. For instance in the financing of small and mediumsized companies. A lot of people invest in cryptos, and they have been designed to improve crossborder payments. You’ll notice that now I’m talking about cryptos, I will shift the focus from the opportunities, to the risks. Cryptos are a development that demands the vigilance of regulators and supervisors. So far, they have not developed into the deeply rooted and widespread payment systems some might have hoped for. To date, cryptos have a modest financial footprint compared to the rest of the financial system. The lack of widespread use is partly caused by an issue that keeps haunting cryptos. Some consider this issue to be inherent to their design. And that is their potential use for money laundering and other illicit activities. A system built around circumventing central oversight is bound to attract certain types of people. The anonymity that cryptos guarantee is both a help and a hindrance to their development. Another reason why current cryptos are generally an unsuitable replacement for our trusted currency and payment systems, is their volatility. It makes them unattractive as a unit of account or store of value. As there is no supervisor, you hold cryptos at your own risk, and your investment is not guaranteed like it is at a bank. Failures or hacks of crypto wallets have already led to significant losses for consumers. Also, many initial coin offerings fail as they cannot generate an asset that keeps its value, even for a couple of days, leaving investors behind with a useless and worthless token. Last but certainly not least, cryptos and the underlying technology are still far less efficient than our current payment systems, as I explained earlier. So the use of cryptos is still limited. But if impediments can be overcome, we might see their more widespread use. Let’s look at this scenario from a central banking perspective, as we at the Dutch central bank are ultimately responsible for the good functioning of the financial system. Such a development could have implications for financial stability. The Financial Stability Board will soon publish a report highlighting the risks. I am honoured to chair the committee that drafted the report, so let me share some of our main findings. Firstly, more widespread trading of cryptos may lead to reputational risks for financial institutions, and affect confidence. Secondly, we see possible risks arising from direct or indirect exposures of financial institutions. Banks’ exposure to cryptos is currently very low or non-existent, as they are often prohibited from crypto investment. However, at some stage, financial institutions may still acquire direct holdings in crypto providers or provide credit to these firms. We also see risks that could arise if cryptos become widely used in payments and settlement. Widespread adoption of cryptos in payment systems may limit authorities’ ability to enforce laws and regulations in parts of the financial system. And finally, we see possible risks from market capitalisation and wealth effects. Crypto-asset markets could become more important in particular jurisdictions if market capitalisation grows significantly larger and ownership spreads. This could then have an impact on the real economy via wealth effects. Regulatory response We are still far from such a scenario, where cryptos have major implications for financial stability. But we central bankers now have a framework for monitoring these potential risks. And while cryptos do not currently present risks for financial stability, we’re still keeping an eye on them. We do so based on concerns for the integrity of the financial system as a whole, and for investor and consumer protection. That is also why different jurisdictions have taken measures to cope with the growing risks of cryptos. Examples include anti money-laundering guidelines, regulatory requirements for the financial sector, and measures to improve investor and consumer protection. The international regulatory community should formulate an appropriate response to these risks. A coherent anti money laundering framework for cryptos, as announced by the Financial Action Task Force, is certainly a step in the right direction. Given the international character of cryptos, a global or European approach is needed. But that will take time. Meanwhile, we at the Dutch central bank are assessing the possibility, together with the Authority for the Financial Markets, of a proportional supervisory framework for cryptos. As it would be impossible to regulate the whole crypto universe, our current thinking is that regulation and supervision should first focus on the intersection of the crypto ecosystem with the regular financial system. After all, the main rationale for our supervision, underpinned by our legal mandate, is to safeguard the integrity and resilience of the financial system. The exchanges where cryptos are bought and sold are where the ‘new’ and the ‘old’ financial systems overlap, and where we will focus our supervisory efforts. Conclusion You still have a full schedule ahead, and I’d like to have some time at the end for questions, so now I’ll conclude. I have tried to highlight some possible benefits of DLT and blockchain for the financial system. The technology is nascent, yet there are several interesting use cases that signify its potential. Central banks are keeping a close eye on new developments, and many of them are experimenting themselves. They also do this to assess and monitor risks stemming from new technologies. We should be especially vigilant about developments in cryptos. While they, too, could represent opportunities, there are considerable risks both for individual investors and in time, possibly the financial system at large. An appropriate regulatory response should be formulated, commensurate with these risks. Central banks and regulators need to find the right balance between seizing the benefits of technological innovation on one hand, and coping with possible new risks on the other. For us, blockchain’s evolution in the financial system is ultimately a balancing act. | netherlands bank | 2,018 | 10 |
Speech by Ms Nicole Stolk, Executive Director of Resolution and Internal Operations of the Netherlands Bank, at the EIOPA (European Insurance and Occupational Pensions Authority) Seminar "Recovery and Resolution in Insurance", Amsterdam, 25 October 2018. | “The Dutch recovery and resolution regime for insurers” Speech by Nicole Stolk at the EIOPA Seminar “Recovery and Resolution in Insurance” Amsterdam, 25 October 2018 At the EIOPA seminar on recovery and resolution in insurance, Nicole Stolk gave an overview of the new Dutch regime for recovery and resolution for insurers. Before an audience of many other European resolution authorities, she sketched the toolkit, the public interest test and the governance De Nederlandsche Bank has set up. New task: resolution for insurers The timing of this seminar could not have been better. That is because the Dutch Parliament is just about to pass the new Act on Insurance Recovery and Resolution. At the same time, we at De Nederlandsche Bank still have many details to work out in how we implement this Act. And the clock is ticking. The Act is expected to come into force on the first of January 2019. So we only have a short time to prepare for this new reality. And I am also new. A new Director. With a new task. It is special to be here at the start of this new resolution regime. And to help this new reality take shape. The Netherlands is one of the first countries in Europe to implement a resolution regime for insurers. Why did we decide to move forward on a national level? One of the reasons was that our old toolkit had several shortcomings. Some instruments were not available, or could only be used in limited ways. These shortcomings became very clear when Dutch financial group SNS REAAL, ran into problems in 2013. The government had to step in, and the banking and insurance group was nationalized. But if we’d had the new insurance resolution regime back in 2013, the outcome might have been different. With a better toolkit, and the possibility to conduct resolution planning, there might have been alternative solutions. However, SNS REAAL was not the only case. During the crisis, several Dutch insurers needed state support. This showed that not only banks, but also insurers, could be “too big to fail”. However, the insurance sector also faces difficulties today. Life insurers are under pressure from low interest rates. And from changes in Dutch fiscal policy. That is why this new regime is needed. It will prevent future bail‐outs, and offer policyholders better protection. But the development of this new regime has also sparked new debate. Debate on whether policyholders should pay for the mistakes insurers make. Debate on which insurers should fall under the regime. And debate on whether a national framework threatens the level playing field. Today, I want to give you a bit more insight into how the Dutch recovery and resolution regime for insurers works. Those of you familiar with the BRRD – the Bank Recovery and Resolution Directive – might recognize some of these resolution tools and practices. However, practical implementation for insurers can sometimes be very different than for banks. I’d like to focus on three features in particular: ‐ the resolution toolkit ‐ the public interest test ‐ and governance under the new regime. These three aspects should provide a good overview of the new regime, and how it works. If you would like me to clarify any points during this presentation, feel free to ask. But if you have more general questions, please save them until the end. There will be plenty of time for discussion afterwards. Part I: The Dutch Resolution toolkit So let’s first look at a couple of items in our resolution toolkit. Some of the resolution instruments are not new to DNB, as they were also part of our previous regime. However, they may have gone under a different name. Or their use may have been subject to more limitations. Resolution instruments The four resolution instruments are basically the same as in the BRRD: bail‐in, sale of business, bridge institution and asset separation. With a bail‐in, we can write down or convert equity or debt, or restructure insurance policies. This instrument is not completely new, as DNB could already change insurance contracts and pass losses on to shareholders. But there are some differences. For instance, in the past we were only able to change insurance contracts in combination with a portfolio transfer. The new Act makes it possible to change insurance contracts within an insurer. Another difference is that an ex‐ante judicial review is no longer needed before we can use resolution instruments. As of next year, DNB can use resolution instruments without Court permission. A bail‐in can be a controversial instrument, especially when it is possible to bail‐in policyholders. There is one important point to remember here though. And that is, it is only possible to use a resolution instrument when no creditor will be worse off than in insolvency. With a bail‐in, the insurance product can be continued, so policyholders can retain their product and their coverage. Tomorrow, the Dutch Ministry of Finance will provide more details on the bail‐in. The second instrument, the sale of business, enables us to sell the shares of an insurance group. Or the shares of a troubled entity within the insurance group. Or to sell an insurance portfolio, without the shareholders’ consent. This was already part of DNB’s toolkit. However, the bridge institution is an instrument we have never used before. It allows us to transfer an insurer, or an insurance group entity, or part of that entity, to a semi public company. During this time, the insurer is not allowed to compete on the market. The bridge institution is only a temporary solution, and it buys us time for a Sale of Business. When setting up the bridge institution, we can also benefit from our experience in bank resolution. The last instrument is asset separation. This allows us to transfer assets, rights or liabilities to a semi‐ publicly owned asset management vehicle. In the banking sector, this vehicle is also known as the “bad bank”. The toxic assets or liabilities can be removed from the balance sheet, to limit the risk and make the insurer more attractive to other buyers. This instrument is only allowed in combination with one of the other instruments, because the insurer also has to bear some of the losses. Other resolution toolkit features Next to the four resolution instruments, the resolution toolkit also provides another crucial feature: the possibility to conduct resolution planning. We will prepare a resolution plan for insurers that pass the public interest test. I’ll go into more detail about this test later on. The resolution plan identifies possible impediments to resolution. And the new resolution regime gives us powers to remove these impediments, if necessary. This contributes to a resolvable insurance sector. Resolution planning ensures that any failures result in lower costs for society, and reduces the risks for financial stability. Finally, it is good to point out some key differences from the bank resolution toolkit. First, the absence of loss‐absorbing capacity. In bank resolution, there is a major focus on loss‐absorbing capacity. The bank resolution experts among you will be familiar with the European and international standards in this respect ‐ MREL and TLAC. However, the Dutch Finance Ministry has decided not to require insurers to have an additional layer of loss‐absorbing debt. Traditionally, this layer is very thin for insurers. That means that a bail‐in could affect policyholders sooner. On the other hand, introducing loss‐absorbing capacity could drastically change the business models of Dutch insurers. This could in turn lead to higher costs for policyholders. The second difference is the absence of a guarantee scheme. Where we have a Deposit Guarantee Scheme for bank customers, there is no such Insurance Guarantee Scheme for Dutch policyholders. This means that a resolution instrument can have a direct impact on society. We have to clearly explain why resolution is still better for that policyholder than insolvency. To sum up, the resolution toolkit contains four resolution instruments, and the possibility to conduct resolution planning, including the removal of impediments. But it lacks two of the features that are a central part of banking resolution. Part II: Public Interest test This new resolution toolkit is very powerful, but also needs to be handled with caution. That’s why the regime is based on proportionality. The default option for an insurer is always insolvency, unless this causes severe negative effects. For banking resolution, there is a public interest test that determines whether resolution tools should be applied to individual firms. A comparable approach is developed for the resolution of insurers. The public interest test determines which insurers cannot go into insolvency without severe negative consequences. This test is different from the public interest test in bank resolution. That is because the effects of a failed insurer are also different. Insurers that pass the public interest test, will be subject to resolution planning. As you can see here, the starting point of the resolution decision is similar to the BRRD. Insurers can only be put into resolution when they are failing or likely to fail, when market solutions have been exhausted and when resolution is in the public interest. Now the important question is: When is resolution in the public interest? There are four criteria that guide the public interest but the first one, the protection of policyholders, needs to be combined with at least one of the other three. These other three objectives are: ‐ avoiding severe disruption to society ‐ preventing significant severe impact on financial markets or the real economy ‐ and protecting public funds. In practice, the impact on society and the economy will create the most discussion. To provide some guidance, the explanatory note to the new Act states that the public interest will depend on the size of the insurer, the number of policyholders, the type of product offered and the current economic situation. It adds two criteria for applying the test: technical provisions of at least one billion euros, or at least one million policyholders. Of course, this is just general guidance and the public interest needs to be determined case by case. At first glance, it seems that between ten and twenty insurers in The Netherlands could be eligible for resolution and resolution planning. It also means that the scope of the resolution regime not only focuses on systemic insurers. But also on the insurers that can have an impact on the Dutch society, financial markets and economy. Part III: Governance Instruments, rules and tests are important. But they could become dead letters when it isn’t clear who should do what at what moment. So, I’m glad the new resolution regime also introduces a specific governance model. This is the third feature that may be of interest to you. In this respect I will first discuss the decision‐making process, and then proceed to the internal organization. As you may know, our governing board is a collegial body that takes decisions by consensus. When it comes to resolution planning, all board members have equal voting rights. However, in terms of decisions regarding resolution execution, the board member for resolution has a casting vote. Although I do of course hope and trust I will never have to use that casting vote… The board member for resolution cannot also be the board member in charge of supervision. At DNB, we have decided to make one board member responsible for bank and insurer resolution, and for the deposit guarantee system. And that’s me. Below board level, we discussed whether insurance and banking resolution tasks should be two different departments. Or whether they could be combined. Because of the similarities in the resolution regime, and the experience that bank resolution has gained, we decided to combine the two resolution tasks into one directorate. The combination of bank and insurance expertise also benefits the resolution planning for bank‐assurance institutions. This is because it brings together different perspectives at an early stage. Within the resolution division, we have started setting up a designated unit for insurance resolution. The unit will ultimately consist of fifteen people. Some of them will focus more on horizontal topics, such as the resolution toolkit. Others will focus more on the verticals. Or in other words, the resolution planning of individual insurers. This is the same setup as for bank resolution, and has proven to be an effective approach. After figuring out the basics for insurance resolution, we aim to further integrate the task with bank resolution. Bank resolution already works within a matrix organization with the DGS function. There is quite some overlap on certain topics. Good examples are crisis management, setting up a bridge institution, and the Sale of Business procedures. On other topics, such as valuation techniques, it is very likely we will team up the functions much earlier. To conclude, the governance is similar to bank resolution. This is not surprising, given the features of the resolution Act, and the potential benefits from cooperation between the two resolution tasks. Summary To sum up, I have tried to give you a bird’s eye view of the new resolution function. However, there is of course much more to explain. With respect to the resolution toolkit, it has become clear that DNB will have four resolution tools. These can of course can be combined. Insurers will be subject to recovery and resolution planning, with the possibility to remove impediments to resolvability. But of course, there is a safeguard to this regime, which is the public interest test. Because insolvency should always remain the default option for an insurer. In addition, creditors can never be worse off in resolution than in insolvency. And governance is similar to bank resolution, in terms of decision‐making and internal organization. Closing remarks Although this resolution regime is a big step forward, there is still a lot to gain from a European perspective. Different countries have shown an interest in a resolution regime. Some of them, such as the Netherlands, have started to build one. This potentially creates differences between countries. At the same time, large insurers have cross‐ border activities and regulation. Solvency II aims to establish a level playing field within Europe. The challenge we face is ensuring European citizens are equally protected, despite different national approaches within the EU. Ultimately, I am very excited about the Dutch resolution regime. And I still hope we will make progress on a European level as well. So let’s discuss your ideas and experiences so far, and learn from each other. And keep building together, towards more equal and adequate protection within the EU. | netherlands bank | 2,018 | 11 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Global Risk Regulation Summit, Risk Minds International, Amsterdam, 3 December 2018. | “Rethinking financial stability; Evaluating regulatory prime concerns a decade on from the financial crisis” Speech by Klaas Knot, at the Global Risk Regulation Summit, Risk Minds International Amsterdam, 3 December 2018 At the Risk Minds International Conference, 3 December, Klaas Knot reflects on the developments since the onset of the financial crisis in 2008. The implementation of the financial reform agenda is advancing and the European banking sector is in safer waters. Looking forward Knot recognizes three elements of focus: completing implementation & evaluating reforms; improving the business model sustainability and market confidence in European banks; and being alert to the buildup of leverage outside the banking sector. Knot concludes that the financial industry is continuously evolving, and financial regulation will have to follow suit. Good morning, and also on behalf of the Dutch Central Bank welcome to Amsterdam! December is the time of year to reflect and the time of year to look ahead. 2018 was a special year, as it marks the tenth anniversary of the onset of the global financial crisis. Many times I have heard: “ten years since the start of the crisis”. But so far I have never heard anyone frame it in a more positive way: “It is the tenth year without a new global financial crisis materializing!” But maybe that is only natural, as central bankers and supervisors would never celebrate a crisis that did not happen. Looking back to the situation ten years ago, we were in the midst of immense financial chaos. Many factors contributed to the crisis, I will not go into them, but years of deregulation and resulting gaps in regulation were definitely part of the story. What I will do today, is to try to shed light on the prime regulatory concerns we have right now, divided into three main areas: First, I would like to reflect on the financial reform agenda that has been carried out. My message there will be that we have made good progress but we still have work to do.We need to consolidate, implement and evaluate. Second, I will argue that the European banking sector has to move from safety to soundness, with the key take away being that we should promote further integration and improve efficiency. And third, I will outline my view on financial stability going forward. Financial stability being a concept that evolves over time and should incorporate new developments and risks. 1. The financial reform agenda So first let us look at the reforms carried out in the aftermath of the global financial crisis, which prompted a fundamental rethink of financial stability. In the landmark April 2009 summit in London, G20 leaders pledged to do whatever was necessary to rebuild trust1. Subsequently, supervisors and regulators worldwide, under the leadership of the Financial Stability Board worked to repair the financial system and strengthen financial regulation. This included bringing systemically significant institutions such as hedge funds under supervision. They also pledged to increase the requirements for regulated financial institutions. Within a relatively short time frame, the foundations for reform were laid. These concerned Too-BigTo-Fail (TBTF), the OTC markets, CCPs and the insurance sector. And most importantly with respect to the banks at the core of the financial system: the Basel III agreements. The implementation of this financial reform agenda is advancing2. Initially the focus was mostly on the banks, and this has led to at least four positive developments. First of all, the Basel III reforms increased both the quantity and the quality of capital that banks must hold. G20 London Summit – Leaders’ Statement – 2 april 2009 FSB (2018): http://www.fsb.org/wp-content/uploads/P281118-1.pdf Before the crisis banks could get away with as little as 2% Common Equity Tier 1 capital. As the figure3 shows, the Basel III reforms changed the composition of the capital requirement, by increasing the share of CET1. In addition CET1 has been strictly defined, increasing the quality of capital. Plus we put more emphasis on stress testing and pillar 2, and introduced macro-prudential buffers. For the first time we also introduced global liquidity requirements. Before the crisis banks became overly reliant on short term funding. The introduction of the Liquidity Coverage Ratio, which is one of the global liquidity requirements, reduced this increased reliance on short term funding again. The graphs illustrate this development over time for Dutch banks. The left-hand graph looks at all funding that needs to be repaid within the next 30 days excluding open-maturity items, such as retail deposits.4 The graph on the right side confirms this trend. Debt securities can be considered long-term wholesale funding. The decline in the share of repos and reverse repos compared to other sources of wholesale funding illustrates the increased tendency towards more long-term funding. Figure from Citi Research, retrieved via Valuewalk.com (2013), “Basel III Will Create New $1 Trillion Hybrid Debt Market”, accessed in November 2018. The graph looks at the duration of funding. The line ‘Short term funding small definition’ is the funding to be repaid within the next 30 days excluding open-maturity items, e.g. retail deposits. Sample consists of Dutch banks only. Secondly, a greater focus was introduced on cross-border activities and consequently cross-border supervision. In Europe we even went a step further and introduced joint supervision via the Single Supervisory Mechanism. This strongly increased EU cooperation and harmonization, and improved the quality of supervision of all EU banks. The third improvement was the creation of a resolution regime. The resolution framework is implemented in EU legislation and the Single Resolution Fund is being built up. It is approaching the halfway mark and within the next five years we should be able to reach the target level5. And, finally, supervision is also becoming more forward-looking. This includes, for instance, looking at the kind of corporate culture and conduct that has proven to be able to result in financial troubles further down the road. In the Netherlands we were among the frontrunners here. This is not an easy issue to address, but it is gaining traction internationally, as demonstrated by the Irish Tracker Mortgage Examination6 and the Australian parliamentary Review of the four major banks7. This approach is now also an element of the SSM toolkit. The list of improvements is impressive, and worthwhile to consolidate. Acknowledging nonetheless that the implementation of the reform agenda is not yet complete, I want to draw your attention to two challenges. The first challenge is confronting regulatory fatigue, and not forgetting the lessons of the crisis. Although the crisis broke out only ten years ago, its memories begin to fade and in some corners of the industry a renewed push for deregulation can be heard. Also we ourselves on the public side have been working on developing and implementing the reform agenda for close to ten years now. While tremendous progress has been made, the pace of implementation is not equally convincing everywhere. The exact target level of the SRF depends on banks’ covered deposit volume. Irish Central Bank (2018) Mortgage Tracker Examination Australian Standing Committee on Economics Review of Australia’s Four Major Banks, For example, on the reform agenda for banks, the Basel Committee noted in October 2018 that several member jurisdictions are behind schedule in implementing the leverage ratio, NSFR and large exposure framework. This also hits close to home, as the EU is still working on the implementation of these last three standards. Good news is that the finalization of the European capital requirements legislation (CRR2) is drawing to a close. This gives Europe much needed time to focus on the final part of the reform agenda for banks: implementation of the most recent refinements of Basel III, which should be implemented by 2022. As I also recently argued at the PetersonInstitute8: the current accommodative monetary policy environment makes it even more important to fully implement standards and strengthen prudential buffers. The second challenge is withstanding the call for dilution. Across the globe I observe a tendency to dilute standards. This tendency presents itself on different fronts. Examples include relaxation of credit origination standards, application of preferential risk-weights, exemptions to the leverage ratio requirement, and tweaks in the definition of systemically important financial institutions. The list of examples is by no means exhaustive. And for all these modifications a certain public policy rationale can be given: stimulating socially desirable lending, fostering financial integration, or whatever. They however come at the expense of reduced loss absorbency in the global banking system. When designing and implementing such a major reform agenda it is inevitable that new distortions enter the system. It is therefore imperative that targeted policy evaluations are also undertaken. Such evaluations should not only focus on whether existing distortions have been sufficiently mitigated, but also whether unintended side-effects have come to the fore. Needless to say, such evaluations should be evidence- rather than sentiment-based. 2. From safety to soundness for banks: the status of the European banking sector So while implementation is proceeding, we could say that we’re not there yet. But it has already left its mark on the banking sector, which is in the midst of an adjustment process. Zooming in at the European banking sector, we see that in many respects the situation is better than ten years ago. Knot, K. (2018), “Speech Klaas Knot Easy Money – Uneasy Finance”, given at Peterson Institute for International Economics, Washington, published on the DNB website Capital was strengthened, leverage ratios improved, and at least some consolidation took place. We are in safer waters, as the results of the EU-wide stress tests about a month ago have illustrated. I understand that you will hear more about this later today. And we need these safer waters, as the banking sector does have plenty of challenges ahead of it. For starters, price-to-book values of European banks continue to be low, at 0.7 on average in the euro area last year, compared to 1.3 in the US.9 Some will argue that this is the result of capital requirements being too stringent. Obviously, I do not agree. The US experience demonstrates that strong requirements and sound business models and valuation can and must go together. But the European banking sector still suffers from structural problems which cause low valuations and low profitability. One important legacy issue is the high level of non-performing loans. The level is declining, but aggregated data mask the fact that there are substantial differences between countries and between individual banks. Moreover, Europe is still overbanked and the banking sector is fragmented. The efficiency of the European banking sector needs improving. Consolidation can help, especially where there are many small-sized banks. In a well-integrated European market it can also be expected BIS (2018), “BIS Quarterly Review - March 2018”, p.84. that more pan-European players will emerge. The conditions for this to happen have already improved, in particular with the creation of the SSM. We do see banks expanding their activities in other EU countries. Cross-border mergers would be another possibility. Whether there is a good economic business case for a pan-European merger is up to the market players themselves. We should however acknowledge that theoretical economic benefits of mergers may not always be attainable. History has shown that there tends to be excessive optimism in takeover deals. In the Netherlands we have had some unfortunate experience with ABN-AMRO in 2007 and 2008 – this kind of crisis does not bear repeating! Also, more complex institutions are more difficult to manage, not to mention the difficult task of integrating IT systems. From my perspective, financial stability considerations need to be taken into account as well. A crossborder merger may increase contagion risk, as financial sectors become more interconnected. After having addressed Too-Big-To-Fail problems at the national level, we would not want the problem to resurface at the European level. Banks could well become more difficult to resolve, as mergers typically make them larger and more complex. Of course the system has been strengthened to meet such concerns. But it has yet to be proven that this has eliminated Too-Big-To-Fail problems. Financial stability and resolvability must therefore play a prominent role in assessing any merger, including cross-border ones. Resolution plans will have to be credible, deposits must be safeguarded, and minimum requirements for own funds and eligible liabilities have to be met, so there is enough loss absorbing capacity. I think it was Mervyn King or Charles Goodhart who once said that banks are global in life but national in death. In Europe, we have tried to address this contradiction by establishing both the Single Supervisory Mechanism and Single Resolution Mechanism.To arrive at truly European burden sharing, we need a fiscal backstop to the Single Resolution Mechanism, and a European Deposit Insurance Scheme to complete the banking union. Removal of the remaining obstacles involves more ambitious efforts to handle the problems of non-performing loans and addressing the sovereign-bank nexus. Once we succeed in delivering both safety and soundness, the lower risk of failure will lead the cost of equity to go down. After all, risk and return are two sides of the same coin. Before the crisis, underpricing of risk led to excessive risk-taking. With better, safer and sounder banks, risks will be more correctly priced, and structurally lower rates of return on equity can be welcomed from a financial stability perspective.10 3. Financial stability going forward In the first part of my speech I concluded that substantial progress has been made in implementing the agreed post-crisis reforms. Subsequently, I noted that the European banking sector is still on its way from safety to soundness. But we also have to look beyond banking. Risks are migrating, and new risks are emerging. The financial system is evolving and becoming more diverse. Financial stability should incorporate such developments and, where appropriate, regulation should also catch up. The diversity of the financial system presents challenges from a regulatory and financial stability perspective. Tightening micro- and macroprudential policies on the banking system has inevitably lead to an increase in non-bank lending – the so-called ‘waterbed effect’11. DNB (2016), “The return on equity of large Dutch banks”, Occasional Study nr. 5. For evidence, see Cizel et al (2016), “Effective macroprudnetial policy: cross-sector substitution effects of price and quantity measures,” IMF working paper. In particular in the euro area we observed a relative increase in finance by non-banks. At modest degrees of leverage, non-bank lending can be a useful complement to bank lending and reduce the concentration in funding sources. More equity based financing would also increase loss absorbing capacity. Problems however arise if there is too much liquidity transformation and/or too much leverage. In this situation non-banks can become major source of instability. The leveraged loans and high yield bond markets are particularly vulnerable in this respect. High yield debt levels are well above pre-crisis levels in the US, and roughly at pre-crisis levels in Europe.12 The good news is that the direct exposure of European banks seems relatively limited. The bad news is that non-bank financial intermediaries provide a high and increasing share of financing in the high-yield debt market13. Should conditions deteriorate, such non-bank financial intermediaries are directly exposed to considerable potential losses. Increases in credit risk premia would add to that. And perhaps even more important, there could be system-wide spillovers beyond the high-yield debt markets. In the past decade we focused most of our attention on strengthening bank regulation. This was much needed, and on this front much has also been achieved. Now we observe emerging risks within non12 FSB (2017), “Global Shadow Banking Monitoring Report 2016”, Annex 7 p.87. Calculations based on Bloomberg data. bank entities. Regulation of non-bank entities may help to ensure that liquidity and credit risks in all parts of the financial system are well-managed. But if we conclude that from a financial stability perspective excessive debt and leverage of nonfinancial counterparts are actually the main drivers of risk, we could also look for instruments that aim to address these directly, such as borrower-based regulation. The Dutch consumer mortgage market is a case in point here, where we have set limits to both the loan-to-value and loan-to-income ratios that apply to all lenders, banks and non-banks alike. Such an approach could be explored more broadly. 5. Conclusion Ladies and Gentlemen, I want to conclude. After the global financial crisis banking regulation has been significantly strengthened. Efforts should now focus on consolidation, implementation, and evaluation of the reform agenda. The banking sector is in safer waters now. But European banks need to do more to make their business models sustainable and regain market confidence. At the same time we have to be alert to the buildup of leverage outside the banking sector. The financial industry is continuously evolving, and financial regulation will have to follow suit. | netherlands bank | 2,018 | 12 |
Speech by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, at the Netherland's Bank banking seminar, Amsterdam, 11 March 2019. | Fout! Onbekende naam voor documenteigenschap. “Changing gears: about cycling and the future of banking” Speech by Frank Elderson at DNB’s banking seminar Amsterdam, 11 March 2019 At DNB’s Banking Seminar, Frank Elderson delivered a keynote speech, adressing three challenges for the Dutch banking sector. Within each challenge, Frank Elderson indicates what steps have been taken already, and where attention is still needed. Fout! Onbekende naam voor documenteigenschap. When I took up this job as chief supervisor for the Dutch banking sector, summer last year, I realized again how much better shape the Dutch banks are in, than the last time I was actively involved in prudential banking supervision. You see, I was leading the DNB team responsible for supervising ABN Amro back in 2006. I remember going to the Zuidas by bike, parking it right in front of that huge entrance of the ABN Amro building - which wasn’t allowed by the way. That solitary black bicycle, against the sheer backdrop of one of the tallest sky-scrapers of Amsterdam at that time, in a way that bicycle formed an early example of transparent supervision: since everybody knew it was my bike, every time they saw it they knew the supervisor was in the building. Of course, it’s a story with a tragic undertone. The years 2006 and 2007 have a fateful ring to them. We were witnessing the tearing apart of the largest bank in the Netherlands. Less than a year after the consortium took over ABN Amro, on a sunny day people were leaving the Lehman head offices carrying cardboard boxes. The rest is history. How totally different to the picture we observe today! Today I see a banking sector that has weathered the storm, and has emerged stronger. Smaller perhaps, but more resilient, more focused and better capitalized. A banking sector with one of the lowest NPL ratios on average in the euro area. And that leaves the Dutch banking sector in a very good position to seize new opportunities. Opportunities abound, I don’t have to tell you that. FinTech, together with new regulation like PSD2, will drive competition and innovation, and it may trigger the biggest change in how customers interact with their banks since the introduction of the automated teller machine. Andrea Enria just gave some very interesting and lucid thoughts and observations on how this digital future might (or might not!) look like. The green transformation of the economy may be an even bigger revolution. 180 billion euros: that is the estimated additional annual investment needed in the European Union to meet its climate targets for the year 2030. For this to succeed, we need funding, we need fundable projects and we need them to connect. Once the conditions are in place, and we are slowly but surely getting there, it will create tremendous opportunities for banks with the alertness and the capacity for change. But just so I’m not in any danger of sounding like a consultant rather than a watchful supervisor, it’s high time to introduce the word “risk”. For we are not of course entering the garden of Eden. There are plenty of dangerous-looking creatures lurking in the undergrowth, that always threaten to spoil the party. One of them, called Brexit, is just a few weeks. Over the past year you have been active in mapping out and managing Brexit-related risks. Ensuring that in the event of a hard Brexit, the continuity of your services will not be jeopardized, and you will not be exposed to material risks. Still, we need to be vigilant for this impact in the coming weeks. And then we have the ‘animals’ that are all too familiar to us, like the risk of an economic downturn and a change in risk perceptions in financial markets. You know them, we know them, and I will not discuss them in detail now. But apart from these more mainstream risks, as I perhaps somewhat disrespectfully refer to them, today I would like to focus on some specific challenges. Three serious challenges that need to be met, in order to be ready for the new banking future. 1st challenge: AML/CFT First of all, after all that happened last year, I cannot speak about banking supervision in general without mentioning AML/CFT. Last year, a significant number of banks came under public and political scrutiny, because they failed to fulfill their role as gate-keepers in the fight against financial crime. By doing so, banks are risking large fines for breaking the law, they run the risk of facilitating all kinds of crime that undermine the fabric of society, including terrorism and they are also undermining trust in the integrity of the financial sector. This has to change. And I have spoken at length with many of you about this. Of course, this problem is not unique to the banking sector, but you have a special responsibility. Because you are the electricity, the heating and the running water of the economy, and the bulk of the money flows through your balance sheets. Fout! Onbekende naam voor documenteigenschap. Luckily, there are signs that executive boards of banks are starting to take their responsibility in this area more seriously. As DNB, we will continue our supervisory investigation into whether banks manage AML/CFT-related risks sufficiently and comply with the relevant legislation. Wherever they do not, we will enforce compliance. In the meantime, we will continue to facilitate your efforts where possible, to make processes for customer due diligence and transaction monitoring more efficient. For example through cooperation within the sector. Also, we are brainstorming with some of you and with public partners, like the Public Prosecutor, on how to deal with this problem at the core. For example by finding ways to reduce the estimated tens of billions euro of illicit funds in the Netherlands. I can almost hear you think: we liked the consultant part better. But this issue is not all doom and gloom. I see an opportunity for you as well. As you may all know, the European Commission has put forward proposals to strengthen European cooperation in fighting financial crime in Europe and to enhance the powers of the European Banking Authority in that area. As DNB, we very much welcome enhanced European cooperation, because money laundering and terrorist financing are problems of an international nature and therefore require an internationally coordinated approach. In fact, we see the EC proposals as an intermediate step towards a fully-fledged European AML/CFT supervisor. It might take many years, or it may all go much quicker than we all in this room can now foresee. But the trend is clearly towards more European harmonization of AML/CFT supervision. And now comes my point: if you succeed in tackling this problem convincingly today, you might turn out to be a shining example of best practices in Europe tomorrow. Whereas your European peers might still be struggling with sorting out their AML/CFT legacy under the new European regime, you would have your hands free to focus on strategic issues. All in all, getting your AML/CFT compliance in order is not only a must today, it may also pay off nicely in the future. 2nd challenge: restoring trust A second serious challenge, in fact one that is connected with all the other challenges you are facing, is restoring public trust in the banking sector. Trust is a tricky thing. The supervisor, the politicians and the banks are talking a lot about restoring trust, but it is ultimately not something you can gain yourself, it is given to you. However, there is a lot you can do to create the right conditions. Like preventing negative publicity, where possible. Like learning to read the public sentiment, which is not easy I admit. By making a contribution to addressing social challenges. For example by supporting the green transition. The way the financial sector supported the negotiations and pledged funding, did a lot to hammer out the national Climate Accord. As chief supervisor for the Dutch banking sector I am very grateful for that. These are all steps that may contribute to restoring trust. Why do I think strengthening trust in the banking sector is important? Isn’t it all going well? Customers are entrusting their savings to you, they continue to take out insurance policies. The banking sector in general is scoring fairly decently in reputation monitors. So what’s the problem? Earlier in my speech I mentioned PSD2, and how it is probably going to change the way customers interact with financial services providers. But these kind of innovations can only succeed if customers trust the new services. A recent survey we did suggests there’s some public skepticism about PSD2. That’s understandable. One of the goals of PSD2 is for customers to benefit from a myriad of new and useful services. But if they have concerns about fraud, or their data being used without permission, they might see it as a risk that’s just not worth taking. As a result of PSD2, banks will lose their privileged access to customer data. New FinTechs are entering the market, that are often ideally positioned to make full use of this data. Fout! Onbekende naam voor documenteigenschap. One of few competitive advantages that banks have, is they enjoy a stronger position of public trust than FinTechs do. Our survey revealed that if customers had the choice between an app offered by their bank, or a similar service from an unknown FinTech startup, they’d stay loyal to the bank they’re familiar with. But no one knows where the tipping point lies. Once it is crossed, PSD2 could drive banks into the background. With customers obtaining services directly from third party providers. That makes public trust an asset of great value for the banking sector at this juncture. 3rd challenge: forward looking risk management The third challenge I would like to mention, and which I think applies equally to you as banks as to us supervisors, is to cultivate our capability to look ahead. To sharpen our receptiveness to developments around us. What do I mean by that? Let me explain. Today, the risk of climate change and the transition to a sustainable economy is on the way to become a permanent element in risk management. Who thought that possible only ten years ago? The same goes for cybercrime. This subject was barely mentioned in risk management twenty years ago, but now it is one of the main risks and banks are investing large sums of money to protect themselves against these risks. Of course, banks and supervisors are continuously assessing the top risks for the financial sector. Banks have made large investments in top notch quantitative models that try to gauge the magnitude of risks. Although this does sharpen our focus, and is undoubtedly important, we must not allow it to cloud our intuition, the propensity we have for being alert to ‘unknown unknowns’, the dark matter of the financial universe. It was ten years ago that several dangerous developments collided in an explosive cocktail that saw the financial system on the brink of collapse. What will be the toxic ingredients of tomorrow? Perhaps the most important aspect of forward-looking risk management and supervision is the recognition that there are certain risks and dangers that will escape our attention, even when they are in plain view. That is why we have capital requirements. Sufficiently high capital buffers are ultimately the last line of defense of absorbing unforeseen losses. And when this is not enough, it is time for orderly resolution. In recent years every effort has been made to develop effective resolution tools for banks. So all in all, although the outlook is moderately positive, leading a bank is certainly not a walk in the park… See it more as a challenging hike, with some nice plush meadows in sight, but also some steep cliffs and canyons to be crossed. In DNB, as always, you find a critical travel companion, with our familiar approach. We value an open working relationship, based on dialogue and mutual trust, which I think is a good Dutch tradition. We are clear about the supervisory expectations and legal requirements, and we offer information and suggestions, and bring together good practices through seminars and roundtables. In case of shortcomings we intervene proportionally and effectively, which also means we act with increasing force if needed. Finally: The SSM Of course, and this is perhaps one of the greatest changes of all over the past twelve years, we are not going about this alone. Today, if you are entering your head offices, you may see not one bicycle, but two. Or a whole lot, if an on-site inspection is taking place. (Actually, this is a figure of speech. We have not yet completely succeeded in transferring our love for cycling to all our good colleagues within the SSM.) Because I am talking about the SSM of course. I think the SSM has been a great improvement in the way we exercise supervision. If I only think back at the situation we were in, back in 2012, when the European Council’s decision about the banking union was taken. And in November 2013 the SSM was formally established.It is hard to believe how much progress we’ve made in just a few years. Many highly qualified staff had to be recruited. A complete supervisory framework had to be designed and be made operational, incorporating the best elements of each nation’s approach to supervision. And a close collaborative relationship with national supervisory authorities developed. It was an astounding achievement, and the ECB deserves much credit for this. Fout! Onbekende naam voor documenteigenschap. We are now in a transitional phase. A phase in which the banking union is steadily taking shape, and the SSM is consolidating into a truly harmonized European supervisor. Based on past experience, I look forward to this new phase with confidence and I am eager to take part in it. That’s how we are continuing, safeguarding a sound banking sector in the interest of depositors and a prosperous economy. Only one last thing: I would love to see more supervisors taking the bicycle when moving around in Frankfurt... | netherlands bank | 2,019 | 3 |
Speech by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, at the NGFS (Network for Greening the Financial System) conference, Paris, 17 April 2019. | Fout! Onbekende naam voor documenteigenschap. Opening remarks by Frank Elderson at the NGFS Conference Paris, 17 April 2019 At the C onference of the Network for Greening the Financial System, the network presented its first NGFS comprehensive report. In it, the Network issued six recommendations. The first four apply to the work of central banks and supervisors, while the last two are for policymakers . In his opening speech at the conference, Frank Elderson outlined why central bankers and supervisors have joined the Network. Elderson describes why they engage in greening the financial system, what the Network aims at and what steps are already taken during the year and a half that the Network exists. Fout! Onbekende naam voor documenteigenschap. In 1163 the first stone was laid of what later became the very heart of Paris. Two hundred years of countless hands, building, carving, constructing together. A marvelous monument. A tribute to what humanity can achieve. When working together, with a commonly held belief in a shared objective. The day before yesterday the Notre Dame - so much Notre Dame burned. And all our hearts burned with her. What was lost was a beautiful cathedral. What was lost was a jewel in the crown of the World’s Heritage. What was lost was a symbol of peace and worship. But what was not lost, is our sense of common destiny. What was not lost is our acute awareness of what we, humanity can achieve, when working together, with a common held belief in a shared objective. In December 2017 the first stone was laid of what later became the NGFS. One and a half years, countless hands, building, carving, constructing together. A marvelous coalition of the willing. A tribute to what central banks and supervisors can achieve, when working together, with a commonly held belief in a shared objective. It’s a therefore only appropriate that we are here in Paris. Paris, where the seed for this initiative was first planted back in 2015, at the Paris C limate Agreement. Paris, where the seed sprouted a couple of years later, at the One Planet Summit. I am happy to say that the Network for Greening the Financial System has now firmly taken root. It is growing at an impressive rate, with shoots popping up all over the pla net. Only yesterday two new members and an observer joined us. A warm welcome to The Swiss National Bank, Swiss supervisory authority and the European Investment Bank. Today, the NGFS has thirty six members and six observers. Our membership spans five continents. One planet. But before I discuss what we have achieved and what we want to go on to achieve… Let’s ask ourselves a question: Why is being here today so important? I: Why it is important? Emissions have increased since the pre-industrial era, driven largely by economic and population growth. This has led to increased concentrations of greenhouse gases, at higher levels in our atmosphere than at any time in the last 800,000 years. Temperatures are already at least 1°C above pre-industrial levels. In 2017, air pollution caused the deaths of almost 5 million people. In 2018, 62 million people felt the impact of extreme weather events. Over 2 million people were displaced. The Arctic is warming up almost three times as fast as the rest of the planet. And as the ice melts, it will cause the sea level to rise. This will undoubtedly have an effect on where and how we live. With rising temperatures comes a decline in biodiversity, water scarcity, and mass migration as land becomes uninhabitable. Problems of poverty and inequality will become even worse. The domino effect of climate events will add to the already formidable challenge of rising temperatures. A transition to a low-carbon, green economy is not a niche. It’s not an optional extra for the privileged few. C limate change affects us all. It reaches beyond economies, borders, cultures and languages. When the world we live in is changing at such an alarming rate, who can afford to sit back? That’s why we need to come together and take action. To create a sustainable future. And that is exactly what we are doing with the NGFS. II: How & why Finance is involved Since the publication of the NGFS progress report last October, it’s no longer a question of asking why we must get involved. Climate-related risks are a source of financial risk. That is why it falls squarely within the mandates of central banks and supervisors to ensure the financial system can withstand these risks. Our mandate doesn’t restrain us. On the contrary, it forces us take a lead in addressing climate change. Next to managing risks, investment needs to be channeled in the right direction. To achieve the EU’s 2030 goals of the Paris Climate agreement, including a 40% cut in greenhouse gas emissions, we need to bridge an investment gap of 180 billion EUR per year. This is both possible and necessary. Because Fout! Onbekende naam voor documenteigenschap. failing to make these investments now is just postponing the inevitable. It means we will have to invest even more by 2020, in order to mitigate the same or even worse effects. When faced with such an imminent threat, inaction is reckless. It will ultimately lead to much higher costs. III: Opportunities I know I may have set alarm bells ringing with this call to action, but it’s not all doom and gloom. The transition to a low carbon economy presents a myriad of opportunities. Opportunities for every one of us. Green investments for instance, offer direct advantages for the economy as a whole: more jobs and more scientific and technological developments. Scaling up the use of sustainable energy and other innovations. As well as more efficient use of our common resources. This will co ntribute to a more circular and sustainable economy. IV: On our way The NGFS offers us a platform to address these issues and take action. It is a way of taking us from where we are now, to where we need to be. A greener, more sustainable financial system must be our destination. NGFS membership has grown exponentially in under one and a half years. All continents are represented, a clear sign that not only climate change, but also climate change action reaches beyond borders, cultures, and languages. In our first NGFS comprehensive report published today, we issued six recommendations. The first four apply to the work of central banks and supervisors, while the last two are for policymakers. However, all six call for collective action and focus on integrating and implementing previously identified needs and best practices. Together, these recommendations aim to ensure that central banks, supervisors, and policymakers are able to support the financial system, in playing its role in a smooth transition towards a low carbon economy. I expect that implementing these recommendations, sharing experiences, and developing practical guidelines could create significant impact.They connect and multiply the convening power of each individual central bank and supervisor. Together, NGFS members supervise 2/3 of global systemically important banks and insurers. Financial markets that fall within the NGFS members’ jurisdictions represent 45% of global greenhouse gas emissions. Yet, we still have a long way to go. The challenge we face is an analytically difficult one, and it is unprecedented. I am sure I have left you in no doubt as to its urgency. So the benefits of us working together to share experience and build practical guidance are monumental. We have now reached the point that we need to move. Move from bold statements to boring but crucial details. From sweeping visionary speeches to the nuts and bolts of the technical eng ine rooms of central banking and prudential supervision. When we’re knee deep in the weeds with these details, we could easily be distracted from our ultimate destination. We can easily become preoccupied by the bushes we cut away, the path we’re finding, the progress we make. But we should never take our eyes off our ultimate destination. It’s not a question of being satisfied with taking a few steps forward. No. We need to actually get to where we want to go. Getting to Paris. On time. That’s where we wan t to be. This means a lot of work from you. The hard core technical part has started. The part where the economists and econometrists deliver. Although you may be experts in the economy rather than ecology, your expertise is equally valuable in both fields. I assure you. Yet climate change is not the only challenge we face. The world will need fresh water. A decline in biodiversity could limit the operations of businesses in a specific region. These risks too, could affect financial institutions. I am pleased to see that these other environmental risks are also appearing on our radar. Fout! Onbekende naam voor documenteigenschap. The next step we need to take, and soon, is to dedicate more resources to environmental risks and how they have impact on our work. A lot still needs to be done. I hope today will inspire you to be bold, think freely, stimulate each other, embrace competition and expand our horizons. Because next year, when we gather again, I hope we will be making the same swift progress. I hope we will be able to show how we have put these six recommendations into practice. And I hope we will have explored new territories with new members. Because with your help, the seeds that were planted here in Paris will grow even further and flourish. Because there is no limit to what countless hands, what humanity, can achieve. When working together, with a commonly held belief in a shared objective. | netherlands bank | 2,019 | 5 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the 2nd SRM-EBF Boardroom Dialogue, Brussels, 5 July 2019. | Fout! Onbekende naam voor documenteigenschap. Progress on the resolvability of GSIBs – the FSB perspective Speech by Klaas Knot at the 2nd SRM-EBF Boardroom Dialogue Brussels, 5 July 2019 At the second SRM-EBF boardroom dialogue, Klaas Knot gave a speech in which he described the efforts in making banks resolvable. He also mentioned areas of concern for the coming years: trends and priorities for achieving resolvability. Fout! Onbekende naam voor documenteigenschap. Let me start by saying that I am here in two capacities, wearing two hats as it were. I am here both as vice-Chair of the Financial Stability Board, the FSB, and as president of the Dutch Central Bank. For this speech I will be wearing my FSB-hat. As you may know, the FSB has actually been the instigator of many of the reforms and policy initiatives on bank resolution, including the topics being discussed today. With the development of the Key Attributes for effective resolution regimes in 2011, the FSB created the blueprint for the European resolution framework. This was followed by the TLAC standard for setting loss absorbing capacity for G-SIBs. So far, this is the only international standard developed by the FSB. Other guidance developed by the FSB covers topics such as bail-in, funding in resolution and operational continuity. In this speech I will be taking the view of an FSB representative with a keen interest in making banks resolvable. This view should provide insight into the trends and priorities for achieving resolvability. Hopefully it will also guide your own efforts, as you work together with the SRB on topics such as: completing resolution plans, implementing TLAC and modelling funding in resolution. And even though the FSB focuses on policy development for G-SIBs, I think these topics are equally relevant for other banks. Resolution planning and achieving resolvability I will start with resolution planning and achieving resolvability, the topic you discussed before lunch. In my view resolution planning has always been a means to an end. It is about getting a deep understanding of how a bank is organized and functions. It is about asking fundamental questions on what functions need to be continued and how to achieve this. Resolution planning forces authorities to consider all these aspects and it focuses the mind. Through resolution planning, the authorities can form an informed view on what is needed to ensure a bank is resolvable. The FSB monitors progress in resolution planning, in its annual Resolvability Assessment Process and reports on this to the G20. The good news is that significant progress has been made, especially in the area of resolution planning. All G-SIBs have a resolution plan that sets out a resolution strategy. The plans have also been discussed between the various relevant resolution authorities involved with the bank in the crisis management groups. However, this in itself does not make banks resolvable. Resolvability means readiness at both the level of the bank and the authorities, to implement the resolution strategy if necessary. At the FSB, we observe that this reality has now also dawned on both authorities and banks. We see the positive trend that authorities are increasingly focussing on banks and their own capabilities to execute resolution strategies. This will take time and effort and requires the allocation of sufficient resources to this task across the board. A lot of the proverbial low-hanging fruit has already been picked by the banks. For instance, identifying and mapping critical services. At the FSB we are finding out more and more that the devil is in the detail. The Resolvability Assessment Process in this context has identified areas in the context of operational continuity where banks and authorities should increase their capabilities. In my view there are three areas of priority when it comes to ensuring banks are ready to implement the resolution strategy. It is perhaps not surprising that two of those are in the domain of data availability in resolution. I am referring to centralizing contract management for critical service contracts in the context of operational continuity, and ensuring good quality data for valuation purposes. If this data is not quickly and easily accessible, implementing resolution in a short timeframe is extremely difficult. The other priority area is understanding how financial market infrastructure will react if the bank is in resolution. If banks in resolution cannot conduct market operations, any effort by any authority is likely to fail. All of the three topics I mentioned require a deep-dive into the DNA of a bank - and then I have not even started on TLAC. TLAC This morning, you also discussed the setting of MREL in order to achieve resolvability. MREL was developed almost simultaneously with TLAC and there are of course a lot of similarities between the two. The TLAC term sheet developed by the FSB determines the minimum amount of loss-absorbing Fout! Onbekende naam voor documenteigenschap. capacity G-SIBs should have. Last month, the TLAC principles were implemented in European legislation through the banking package. This means that, as of last Friday, all G-SIBs in Europe are required to have a minimum loss absorbing capacity of at least 16% of Risk Weighted Assets, plus the combined buffer requirement. The European legislation on some aspects goes beyond the TLAC term sheet, for example by requiring MREL targets for all banks instead of only G-SIBs. Also, the new BRRD2 introduces binding minimum subordination requirements for banks with over 100 billion Euro on their balance sheet. This will ensure that sufficient loss-absorbing capacity is available for bail-in during resolution. The FSB has been monitoring the progress G-SIBs are making in building up loss absorbing capacity. We see that progress has been steady and significant, both in the setting of TLAC requirements by authorities and in the issuance of TLAC instruments by banks. This has been instrumental in enhancing resolvability and boosting market confidence in authorities’ capabilities to address “too-big-to-fail” risks. However, despite all this, we are not at the end of the road yet. The TLAC review that the FSB recently finalized, has shown that additional steps relating to loss-absorbing capacity are necessary. I will address three topics where I believe progress is required. First, it is clear that there will be less issues when bailing-in a subordinated liability compared to bailing in a senior instrument. No Creditor Worse Off issues come to mind in this context. The TLAC term sheet, by way of exception, allows for senior instruments to be counted towards TLAC. In my view, more analysis is required as to how these exceptions influence the resolvability of banks. Second, we have to make sure that adequately distributing loss-absorbing capacity within the group, needs to be prioritized. This means making sure losses in subsidiaries can be upstreamed to the parent company, and capital generated through bail-in can be downstreamed from parent to subsidiary. Without an efficient internal mechanism, bail-in simply will not work. It is good to know: this topic also has the attention of the SRB. Third, further work is needed on bail-in execution. This has also been recognized within the FSB. Both banks and resolution authorities should consider how they can ensure that the execution of bail-in is effective. Executing bail-in is a complex process that involves many actors and actions by both banks and authorities. Bail-in also has distinct cross-border elements, as many banks have issued bail-inable instruments in other jurisdictions. This is an area the FSB will be focusing on this year. I am glad that the SRB and the banks are also making progress with the development of bail-in playbooks. Funding in resolution I will now turn to the topic, that will be discussed this afternoon: “funding in resolution”. This topic, which has often been referred to as the elephant in the room, is now firmly on the radar screen of banks and authorities alike. Within the FSB we have observed that work has slowly started to ensure that funding and liquidity will not be the constraining factor for an orderly resolution. Resolution funding strategies and plans are being prepared. Banks have started building up core capabilities, by developing automated scenario modelling and forecasting to address funding in resolution, in line with the FSB’s guidance on Funding Strategy Elements for an Implementable Resolution Plan. However, this takes time and it requires a different mindset from bankers. So here we encounter a third area of recommendations, after those on operational continuity and TLAC. The area of bank’s capabilities on funding in resolution. Preparing for a resolution scenario goes beyond normal liquidity stress testing and contingency planning in going concern. Banks must be able to estimate and address potential funding needs in a variety of stressed situations and resolution scenarios, by applying even more conservative assumptions than in normal stress tests. In addition, banks need to identify and monitor the collateral that can be mobilized in a resolution scenario. So, I would like to urge everyone around the table to dedicate sufficient resources to this topic tasks and not to consider this as something already covered by recovery planning. Fout! Onbekende naam voor documenteigenschap. Despite efforts undertaken, liquidity gaps may eventually arise when an institution is put into resolution. In particular in a slow-burning crisis situation, there is a risk that in the run-up to resolution, more and more assets are being encumbered or disposed, as part of the recovery strategy. A consequence of this, inevitably is that when the institution is declared failing or likely to fail, there is insufficient collateral left for the institution to fund itself. And here we encounter the fourth and final area of concern: the authorities. Authorities should therefore work in parallel in two directions, to avoid institutions being unable to be resolved because of a lack of funding. First, to avoid ending up in such a situation where all collateral is gone, it is important that the bank is placed in resolution at a sufficiently early stage. In line with the FSB Key Attributes of Effective Resolution regimes, liquidity indicators should be an important element in when authorities determine that an institution is failing or likely to fail. Second, private and public funding mechanisms should be put in place to close any potential liquidity gaps. In line with the FSB Guiding principles, private sources of funding should be relied upon as a first-choice source of funding, to the degree that such funding is available. In addition, an effective public sector backstop funding mechanism should be available as last resort. In several jurisdictions such mechanisms have been put in place in recent years: in countries like the United States and the United Kingdom, through a combination of a resolution fund and a central bank resolution liquidity facility. At the level of the Banking Union, the public backstop funding mechanism is still very much a work in progress. I understand the SRB has been exploring how the Single Resolution Fund can best be used for funding in resolution. There are quite a few challenges that need to be overcome, like the form in which liquidity will be provided and obtaining a rating for the Fund. I am sure the SRB will rise to the occasion on these topics. What has been achieved, is that the ESM will become the common backstop to the SRB’s Single Resolution Fund. This backstop can be used in case the Single Resolution Fund has been depleted. It is therefore also available to provide liquidity support to resolved banks. Yet, we all know this may not be sufficient to cover the liquidity needs of a GSIB This leaves the question of the role of the Eurosystem, with regards to funding for banks in resolution. At the moment, the technical work within the Euro Working Group focuses on ways to access ordinary central bank liquidity facilities. The recent letter from Eurogroup President Centeno mentions further work on proposals on SRB guarantees to the Eurosystem, and on the capacity of the SRB to provide collateral to banks in resolution. You can imagine that, with my central bank hat on, I can only support these initiatives. Whatever the outcome of the technical work, the instrument should be designed in line with the FSB Guiding Principles. This means: it should only be available on a temporary basis, when private funding sources are insufficient, on conditions that minimize moral hazard. Concluding remarks When looking at the progress made on bank resolvability, I can say that from an FSB perspective the glass is half full and that I remain optimistic. Much progress has been made on resolution planning, TLAC and funding in resolution. This has helped to increase the resolvability of the banks and the preparedness of the authorities. The challenge will be to keep up the good work. This means banks should invest in improving their capabilities to execute the resolution strategy. Authorities need to continue to provide the banks with guidance and make sure they are operationally ready for a resolution case. I hope I can count on your efforts in this endeavour of making your banks resolvable, especially in the areas of operational continuity, TLAC and funding in resolution. Thank you! | netherlands bank | 2,019 | 7 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Macroprudential Policy Conference "Real estate taxation and macroprudential policy", Vilnius, 2 July 2019. | Fout! Onbekende naam voor documenteigenschap. “Mortgage Interest Tax Deduction in the Netherlands: A Welcome Relief” Speech by Klaas Knot at the Macroprudential Policy Conference “Real estate taxation and macroprudential policy”, Vilnius, 2 July 2019 Klaas Knot delivered the keynote speech at the 2019 Macroprudential Policy Conference on 2 July in Vilnius, with the theme ‘Real estate taxation and macroprudential policy’. He shared Dutch experiences with real estate taxation and macroprudential policy application, and called for countries to bring taxation and macroprudential policies into line in order to reduce the volatility of housing market cycles and their impact. Fout! Onbekende naam voor documenteigenschap. I’m glad I have the opportunity to exchange views here with you about this important topic. But to be honest, I’m also a little bit surprised that it’s me who has been invited as a Keynote speaker. When it comes to macroprudential policy and real estate taxation, it seems the Lithuanians do a far better job than we do now in the Netherlands, and certainly than we did in the past. While our Loan-to-valuelimit still stands at 100% and mortgage interest deduction (MID) is the most generous in Europe, the Lithuanian LTV-limit stands currently at 85%. And mortgage interest deduction was abolished already in 2009. I can imagine that for the next edition of this conference it would therefore be more appropriate to invite Vitas to Amsterdam, so I can make notes on what he has to say. Nevertheless, let me be so free to share some of my thoughts and experiences with every one of you. Let’s together build on a collective set of lessons learned. Previous crises and downturns have shown us that residential real estate markets are an important concern for both financial and macroeconomic stability. This not only holds for my country, where the drop in house prices starting in 2009 severely prolonged the economic downturn. It is probably also true for a country like Lithuania, where 90% of all households are owneroccupiers. In past decades the total value of residential real estate as a percentage of Gross Domestic Product (GDP) has increased substantially in almost all developed countries. Often this surge in house prices was accompanied by a surge in household debt, which has made economies even more prone to housing shocks. You can see this in figure 1. EST DEU LTU HUN LVA SVN CZE POL SVK ITA AUT GRC JPN USA BEL FRA FIN PRT GBR CAN SWE AUS NLD NOR DNK Figure 1: Household debt as a percentage of net annual disposable income. OECD data From World War II onwards, housing policy in many countries became very much geared towards promoting homeownership. This worked via both favorable tax treatment of housing, and the deepening of mortgage markets. Homeownership rates have in almost all countries been steadily on the rise. The Dutch case is by no means an exception. In this Keynote I would like to share the long experience that my country has with tax relief on mortgage interest. Or, as I will refer to it today: Mortgage Interest Deduction. But also our experience with the new macroprudential tools that were introduced after the global financial crisis. I believe the Dutch case is an interesting example of the distortive power of mortgage interest deduction. And it clearly illustrates why macroprudential policy is especially needed in such an environment. First, I would like to look back at over a century of mortgage interest deduction in the Netherlands, up until the global financial crisis. Second, I will take some time to discuss what measures were introduced in the wake of that crisis. Third, I will discuss in a broader context how I believe macroprudential policy and real estate taxation should ideally work together in stabilizing housing Fout! Onbekende naam voor documenteigenschap. markets. It is in this third part especially that I hope we can combine all insights, thoughts and experiences. The Dutch experience up until the global financial crisis In the Netherlands mortgage interest deduction was introduced already in 1893, by our Minister of Finance at that time: Nicolaas Pierson. He overhauled the tax system and shifted the tax base from mostly indirect taxation towards sources of income. In this new system, a house was seen as a source of income. Rents or imputed rents were therefore taxed, and costs like interest payments could be deducted. Already back then, on a net basis most homeowners and landlords with a mortgage loan received a subsidy, since the rental income was taxed relatively lightly. However, the effects of mortgage interest deduction in the early decades were still relatively contained. Because homeownership rates were very low, namely less than 20% by 1920. Moreover, getting a mortgage loan was nearly impossible for most households since a substantial down payment was required. Figure 2: Homeownership rates the Netherlands. Taken from van de Zeeuw & Kraan (2001) and Eurostat. After World War II in many countries – including the Netherlands – the idea slowly emerged that more homeownership would contribute to welfare, and should therefore be further promoted. In general, the housing shortage at that time meant that governments were willing to take drastic action to stimulate access to housing. The introduction of a mortgage guarantee scheme in 1956 meant that more and more households could access the mortgage market. Since the government guaranteed that the loan would be paid off, lenders were willing to take on additional risk, and were able to loosen their downpayment constraints. Additionally, households that wanted to buy a newly constructed home were eligible for additional subsidies that were introduced to stimulate building - in Dutch called “premiewoningen”. Meanwhile homeownership and mortgage debt were steadily on the rise. By the 1970’s 35% of all households were owner-occupiers. And by the early 90’s this number stood at 45%. Currently the homeownership rate in the Netherlands is almost 70%. From the 1990’s onwards the Netherlands experienced a spectacular surge in mortgage debt and house prices. From 1995 to 2008 house prices more than doubled in real terms. Mortgage debt increased in the same period. from around 50% of GDP to over 100% of GDP, as you can see in Figure 3. Fout! Onbekende naam voor documenteigenschap. Figure 3: Mortgage debt as a percentage of GDP in the Netherlands (1950 - 2018) It is in this period that households and mortgage suppliers discovered “innovative” ways to fully exploit the tax advantages of mortgage interest deduction. New mortgage products were introduced that combined interest-only mortgages - and hence, maximum deduction - with saving or investment accounts that allow for deferred amortization. At that time mortgage suppliers also gradually started to loosen their credit standards. First, by allowing households to increase borrowing by including partner income for determining the maximum mortgage. Secondly, by an ongoing increase in the loan-tovalue of new mortgages. Borrowing at 110% LTV was not an exception anymore by the early 2000’s. Additionally, households started to withdraw home equity by taking out an additional mortgage loan. Although I would be the first to admit that these practices in hindsight seem outrageous, we must remember this: In part the high levels of borrowing by Dutch households are the flipside of high mandatory pension savings in the Netherlands, where contribution rates of around 20% of gross income are not exceptional. Liquid savings of Dutch households – for instance to use for a downpayment – are therefore quite limited. With homeownership being subsidized to this extent, the only viable option for many households to fulfill their housing needs, was to therefore to take out very high mortgage loans. The global financial crisis and policy response As I mentioned before, the global financial crisis followed by the Eurocrisis, hit the Dutch economy relatively hard. One can imagine that the high LTV-ratios of Dutch household and a fall in house prices resulted in many households facing negative home equity. At its peak 35% of Dutch homeowners were “underwater”. It will come as a surprise to most of you, but foreclosures and arrears remained at very low levels during this entire period. Dutch households always keep meeting their mortgage payments. Some believe it is deeply rooted in our Calvinist culture. I believe that our strict personal bankruptcy procedures play a large role as well. The position of mortgage creditors in the Netherlands is very strong. Banks and other creditors may even evict residents from their homes without judicial interference. But while households kept making their monthly payments, they had to drastically cut consumption. Fout! Onbekende naam voor documenteigenschap. Relationship house prices and consumption (estimated coëfficient) 0,2 correlation coëfficiënt 0,7 0,1 0,0 -0,1 Home ownership with a loan (% population) Figure 4: Correlation of houseprices and consumption for selected countries. DNB Bulletin (2018) link. A recent study at DNB showed how, internationally, the response of consumption to changes in house prices is positively related to the share of households with a mortgage loan. The dot in the top right corner of Figure 4 represents the Netherlands. So while the direct losses for financial institutions were relatively low, the macroeconomic consequences were severe. The recession following the financial crisis made it clear to policymakers and politicians that mortgage debt had risen far beyond optimal levels in the Netherlands and led to excessive macroeconomic volatility. Finally the time seemed right for a discussion on the effects of mortgage interest deduction. The Dutch Central Bank – together with other economic advisors - had already recommended scaling back mortgage interest deduction for some years. However, the M-word had up until then been a political taboo. But now, also in light of the fiscal deficit at that time, cutting foregone tax on earnings due to mortgage interest deduction was finally on the table. In 2011 the total tax advantage due to mortgage interest deduction amounted to 14 billion euros, roughly 2.5% of GDP. Eventually, the cabinet took various measures to reform the housing market. I would like to highlight three of them. Firstly, for new mortgages it was decided that they would only qualify for mortgage interest deduction when the loan was fully amortized over a 30 year period. Figure 5 shows the result of that policy measure becoming effective in 2013. Fout! Onbekende naam voor documenteigenschap. Figure 5: Outstanding debt (in billions of euro) by year of origination. Taken from DNB Financial stability report (2017) link. While annuity mortgages were almost non-existent in 2012, in 2013 the new flow contained a large volume of them. [The fact that there are still interest-only mortgages and savings mortgages in the flow, is mainly due to existing mortgages being rolled over.] Secondly, an LTV-cap was introduced in 2012 at 106%. From 2012 the LTV-cap was lowered yearly by 1 percentage point and it remains at 100% today. Most international guests will probably raise their eyebrows: can you even call that a cap? But for many Dutch households this cap was actually binding. Households had gotten used to being able to finance transaction taxes, broker fees and solicitor fees using their mortgage loan. Thirdly, DSTI-limits that appeared to have not been applied consistently before the financial crisis, were written in law. They now apply to all mortgage suppliers – banks and non-banks. Although I welcome the steps that have been taken, including recent steps to seriously start scaling back the maximum rate at which mortgage interest can be deducted, the situation in the Netherlands is still far from ideal. Mortgage interest deduction is still among the most generous in the world. And although the Netherlands is one of the few countries where both DSTI -and LTV-limits apply, both of them are very high by international standards. As president of the Dutch Central Bank I will therefore keep stressing that additional reforms are needed. Fout! Onbekende naam voor documenteigenschap. Figure 6: Contribution of MID to marginal costs of housing investment. Graph taken from EC (2014) Tax reforms in the EU 2014 link. Why macroprudential policy and taxation are both substitutes and complements Taxation in most countries favors owner occupied housing. In some cases very explicitly so, via mortgage interest relief, as you can see in Figure 6. In other cases, because housing wealth is taxed much less than other sources of wealth. Tax systems therefore generally contribute to cyclicality instead of containing it. Macroprudential policy is therefore often partly in place to offset the negative elements of the taxsystem. This is the most clear when the tax system induces a debt-bias, as it does in various countries that still offer mortgage interest deduction. However, in fact it also holds when the tax system favors investment in housing over other sources of wealth. In most countries, the idea that homeownership is the preferred tenure for all households, is still deeply embedded in society. From an economic perspective the case for homeownership over renting is much less clear. The often mentioned pros, like better maintenance of properties, and cons, like less labor mobility and more debt - are at best in balance. From a fiscal perspective I therefore believe that countries should strive to move to a tax system that is more or less neutral towards homeownership. Not only does this benefit financial and macroeconomic stability via structurally lower debt and real estate prices. It also creates a level playing field for private rental housing. Currently, the supply of housing in this segment of the market is often suboptimal. In my country this segment still dominated the housing market in the post-war years, but now only makes up a small fraction of the total housing stock. So yes, I believe that proper real estate taxation and macroprudential policy are to some extent substitutes. But fiscal incentives are not the only source that can amplify residential real estate cycles. The feedback loop of adaptive expectations of house price growth remains another source of risk. Exuberance leads to more exuberance, panic to more panic, also when taxation does a better job than it does today. Macroprudential tools such as DSTI -and LTV-limits can structurally limit this mechanism and at the same time protect households from over indebtedness. I realize that I formulated the typical nuanced answer you can expect from an economist: “real estate taxation and macroprudential policy are both substitutes and complements”. I hope for everyone here in the room that the panelists in the next session – where this question will be discussed more extensively – will be a bit less nuanced so we can have a lively debate. Fout! Onbekende naam voor documenteigenschap. Concluding remarks Before we move to this next session, I would like to say a few more words and conclude. As I stated at the start of this Keynote: the impact of volatile housing markets on financial stability and macroeconomic stability and performance is significant. To me, the Dutch case clearly illustrates that too much household debt severely exacerbates this mechanism. In my view, current tax systems often contribute to cyclicality, by either incentivizing debt financing or stimulating investments in housing over other investments. In such an environment macroprudential instruments are partly in place to offset these features of the tax system. Ideally however, I would like to see tax systems and macroprudential instruments working in tandem, to structurally limit the risks of excessive house price growth and leverage. Therefore I believe that for us, as policymakers, there are still important steps to be taken the coming years. In various countries there is still room for improvement to extend the macroprudential toolbox or fine-tune the current instruments. Moreover, in most countries the tax system can be improved a lot to reduce cyclicality. Residential real estate taxation should therefore gradually transition to a level much more comparable with other sources of wealth. I want to emphasize here that when it comes to macroprudential tools and real estate taxation, I believe in a structural approach. Using these tools to “lean against the wind”, by making discretionary changes to them through the cycle, is a far more difficult and risky exercise for us policymakers. That all said, I would like to thank everybody here for coming and giving me this stage. I really hope this conference will push this essential issue higher up the policy agenda. | netherlands bank | 2,019 | 7 |
Keynote speech by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, at the International Capital Markets Conference, Frankfurt am Main, 30 August 2019. | Fout! Onbekende naam voor documenteigenschap. We all play a vital role Keynote speech by Frank Elderson at the International Capital Markets Conference, Frankfurt, 30 August 2019 In his keynote speech on the International Capital Markets Conference, Frank Elderson states that unprecedented changes to our economy are necessary and it should be clear that ignoring climaterelated issues, is far riskier than facing up to them. It requires urgent action to limit the damage as much as possible. And it takes collective action to avoid these irreversible tipping points, actions from central banks, financial institutions and governments. Fout! Onbekende naam voor documenteigenschap. When I walked out of my hotel this morning, the usual line of taxis was waiting for me. Most were of a particular, well-known brand in Germany. The first in line however, happened to be a Tesla. I was thrilled to be driven in an emission-free fashion to this Conference on Climate Change. I told the driver. He loved the idea as well and explicitly asked me to pass on a message to all of you. I promised him I would do so. Currently, so my taxi driver told me, in the entire city of Frankfurt there are four fast-charging stations available. (Fast, by the way, means one hour and thirty minutes…) There are considerably more slow charging stations, but charging there takes five to six hours and they are hence not of use for a taxi driver. Of the four fast ones, often one or more are broken or otherwise not available because fossil cars are parked in front of them. My taxi driver happened to be an optimist: his clients love the zeroemission ride he offers them. He knows that he is part of the future. But he wants that future to start now. He knows that requires investments. And he knows that I am now addressing a room full of people who can make that possible. Who can also choose to become part of the future and can grab the myriad of opportunities that future grants us. Just like he does. If you say that bankers make our world a better place, perhaps not everyone would immediately agree with you. Especially these days! But history illustrates that the banking industry has played a crucial role in guiding the changes that shape our future. For the better. Take our hosts, KfW Bankengruppe. Founded with start-up capital from the Marshall Plan, KfW played a key role in post-war reconstruction efforts. It must have been a daunting challenge – getting the German economy back on its feet after the devastation of war. But that is exactly what it achieved. And more. Through a spirit of cooperation, through a willingness to take on massive responsibility and through ensuring funds were channeled to where they needed to go, ultimately, paving the way for the country to recover and emerge as one of the world’s leading industrial states. Today another wind of change is blowing. And though the challenges we face today are equally daunting, I am certain that once more we can overcome them. And that once again we will show to the world that the financial sector can be a force for good. We’ve come a long way. In 1992, the leaders of the world took a first step by signing the UN convention on climate change. That is over a quarter of a century ago. 25 years in which many more steps have been taken, leading up to the Paris Agreement of 2015. The good news is that momentum is building. And not a moment too soon. In 1992, there was little consensus on the catastrophic effects of rising temperatures. We did not yet know that in 2017, air pollution would cause the deaths of almost 5 million people. We did not yet know that in 2018, 62 million people would be affected by extreme weather events and over 2 million would be displaced because of it. And we did not know that by now, we would be risking our homes, our jobs and eventually even our lives if we don’t drastically change how we live. World leaders took the first step in acknowledging climate-related risks. And it seems that investors and financial institutions are now on the same page. In 1992, the words “climate change” popped up in only 69 Bloomberg articles. By comparison: last year, it appeared in over 22,000 Bloomberg articles. Also, in 1992, seminars like this didn’t cover climate-related issues. This is of course not only true for climate change: “low interest rates” weren’t really a hot topic then either: with the German Bund yield at 8%. But the difference between these two subjects is that interest rates go up and down over time, while the temperature keeps rising. The world has already warmed by about 1 degree Celsius since pre-industrial times, due to human activity. Drastic efforts are needed to reduce carbon emissions now. Otherwise, it is likely we will pass irreversible tipping points in just 12 years. As the IPCC puts it, in their report: “There is a significant risk of crossing critical thresholds and even triggering tipping points as warming goes from 1.5 degrees to 2 degrees Celsius.” So waiting for climate change to become less of a “hot” topic is not an option. It will only get hotter. Inaction is simply not an option. I must admit, in view of the findings of the IPCC and others, I was a bit surprised when I saw the topic of the next panel discussion: “Climate-related aspects in investment portfolios: nice-to-have or compelling necessity?” For me, the question has long been answered and the answer is compellingly clear. Fout! Onbekende naam voor documenteigenschap. At this point, and given all the extensive scientific evidence, it is clear that climate change poses risks beyond anything seen in the modern age. It is clear that we need to make unprecedented changes to our economy and it should be clear that ignoring climate-related issues, is far riskier than facing up to them. So we should not discuss if, but how we respond to climate change. It requires urgent action to limit the damage as much as possible. And it takes collective action to avoid these irreversible tipping points. Today, I would like to focus on what central banks, financial institutions and governments can do. Role of central banks and supervisors Central banks and supervisors are working together to produce a collective response to climate change. But our collective journey together started much later than 1992. Last year, De Nederlandsche Bank hosted the first ever international climate conference for prudential supervisors. This conference was organized by the newly-formed Central banks’ and supervisors’ Network for Greening the Financial System. The NGFS. The NGFS was founded on the initiative of the Banque de France. And I have the privilege to be the first chair of this network. At the conference we came to the conclusion that climate change is a source of financial risk. And one that is squarely within our mandate. This was still unthinkable in 1992, but now, this is a widely-shared conviction. The Network has grown significantly. From the original eight founding members, today, the NGFS brings together 42 central banks and supervisors and eight observers, representing five continents, representing half of global greenhouse gas emissions, responsible for supervising three quarters of the global systemically important banks and two thirds of systematically important insurers. The conference was the first milestone for the network. This year, the NGFS reached its second milestone: a report with six recommendations on how central banks and supervisors should contribute to Paris. In short: central banks can play a catalyzing role in promoting responsible financial markets. As investors, they can strive to make the economy more sustainable by managing the environmental risks of their own reserves. De Nederlandsche Bank has, for example, signed the Principles for Responsible Investment. In the financial sector, we would be considered laggards, as this is already standard industry practice. But in the central banking community, we were the first ever to sign the PRI. The direct effects of our action may be limited, given the size of our investment portfolio, which is 19 billion euros, and given the composition, which is mostly government bonds. But we hope that others will follow, and collectively, the impact will be larger. And apart from the absolute number, we as central banks exert influence by leading by example. The starting point for supervisors is the risk perspective. As I said before, climate change and the transition towards a carbon-neutral economy are sources of financial risk. The financial sector is particularly exposed to physical risks and transition risks. Physical risks refer to the damage of the catastrophic effects of climate change. Assets may by ravaged by climate calamities. And the whole economy may be affected indirectly through weaker growth and lower asset returns. These risks are not just in the distant future. 2017 and 2018 were already the costliest years on record in terms of weather-related disasters. Here in Germany, the hot summer of 2018 caused the closure of parts of the Rhine to commercial shipping, for the first time in living memory. The closure of this vital waterway shaved 0.2% off Germany's gross domestic product. Shipping restrictions were again in place this year following the record temperatures. So it looks like climate-related disruption is here to stay. Even if you are skeptical about climate change or its causes, there is no escaping climate regulation. The risks of stranded assets are very real. This is what we refer to as the transition risk. Financial institutions have significant exposures to companies that emit high levels of CO2. Pension funds and banks, in particular, are vulnerable to their carbon intensive assets suffering a sudden loss in value. Here again, risks are already unfolding. A good example is Dutch legislation in the real estate sector. From 2023 onwards, office properties in the Netherlands will be required to have an energy efficiency label of at least C, resulting in stranded assets, in the form of those offices with an energy label lower than C. The NGFS report calls for the integration of these climate-related financial risks into day-to-day supervisory work, financial stability monitoring and board risk management. The report was the second milestone of the Network. And we expect more milestones to come soon. At the moment we Fout! Onbekende naam voor documenteigenschap. are working on more technical documents, for example a handbook for supervisors on how to supervise climate-related risk. A handbook for central banks on responsible investing. And a good practices guide for financial institutions on conducting environmental risk analyses. So central banks and supervisors are in the process of incorporating a new risk driver. Luckily, we already have a track record in this respect. Once upon a time, no supervisor ever thought about cybercrime, but now we all do. This required no change in our legal mandate. It simply required the realization that cyber risk is a material risk for financial institutions. Likewise, central; banks and supervisors don’t need a change in their legal mandate to deal with climate change. It simply required the realization that climate change leads to material risks for financial institutions and financial stability. Role of the financial institutions and investors As I said, it takes collective action to avoid irreversible tipping points of global warming. Which brings me to what you in the financial sector can do. To begin with, institutions must assess their organization’s exposure to climate risk. This is the first step and the absolute bare minimum of what they must do. Given the rising costs of extreme weather events, no institution can afford to continue to originate loans and invest using old risk identification processes. Institutions must recalibrate and adapt their processes to properly reflect risks. Otherwise, markets and supervisors will do that for them. Building forward looking models is difficult, but developments in this field are progressing fast. And when I say forward looking models, I mean techniques such as scenario planning and climate stress testing. Also, we need to accept that our risk analysis won’t be perfect from the start. If we wait with managing climate related risks until we have precisely quantified it, we will be too late. This is not only true for climate-related risks. It also holds for broader environmental and social challenges. Water scarcity is a source of financial risk. Diminishing biodiversity is a source of financial risk. Human rights controversies are a source of financial risk. Basically, if you want to know the early warning indicators for future policy (and therefore for upcoming transition risks and stranded assets), just look at the UN’s Sustainable Development Goals. These will give you an idea of what activities may be subsidized, forbidden or downgraded. Between 2009 and 2015, for example, Moody’s cut the average credit rating of European power utilities by three notches, partly because of environmental risk. Next year in Beijing, an international Biodiversity Treaty will be signed. So, integrating ESG factors is no longer just for do-gooders. It is now a key risk management tool. After you’ve assessed these vulnerabilities, you need to disclose them too. Because you don’t want to surprise markets with risks that suddenly materialize. I guess I don’t need to tell you that when markets reprice a company’s risk, they do so in a hurry. Companies are already increasing their transparency. Over 800 organizations support the voluntary disclosures of the TCFD, including the world’s largest banks, asset managers and pension funds, responsible for assets of $118 trillion. And what’s more, as from 2020 all PRI signatories will have the obligation to report TCFD aligned indicators. Whether or not they will also publicly report their TCFD score, is their own choice. So, more and more financial institutions are taking steps to evaluate and disclose the threat of climate change. But applying risk management instruments does not necessarily in itself contribute to sustainable development and the energy transition. A bank could for example implement the TCFD but not invest a penny in the sustainable transition. For that very reason, even though I am a central banker and supervisor, I must say that it’s not just about mitigating risks. There are opportunities too. hink about the great demand for renewable energy and new infrastructure, creating new investment opportunities in a low yield environment. Think about the massive supply of green, social and sustainable bonds, giving financial institutions the opportunity to broaden their investment base. Think about the fees you can collect, by actively managing portfolios with the climate in mind. But investing and lending with the climate in mind isn’t yet standard industry practice. We have seen fine examples in the financial sector from forerunners. For example, our host KfW is supporting countries in converting their energy systems in a sustainable manner. Fout! Onbekende naam voor documenteigenschap. But the real economy cannot shift fast enough to meet the Paris Agreement without help from the entire financial sector. The transition to a low-carbon economy requires tremendous amounts of investment. Wind farms have to be built. Households need to be made more energy efficient. And we need to start using cleaner vehicles. So we still have a long way to go: Fossil fuels are still Europe’s dominant source of energy. The European Commission estimates that to achieve the Paris targets, we have to fill an investment gap estimated at € 180 billion per year. This sounds massive, but it is only slightly more than 1% of our combined GDP. Government and corporate investment already adds up to a multiple of this amount. So it should not be difficult to mobilize these funds. And it might even make good business sense to do so. It sounds counterintuitive, but investing with the climate in mind is hot. To keep a competitive edge, financial institutions need to adjust their business model on time. So they can seize these opportunities. You don’t want to miss the boat. especially now that sea levels keep rising. Role of governments As I said, the real economy cannot shift fast enough without help from the financial sector. But in turn, the financial sector cannot act fast enough without help from governments. Therefore, at the same time, governments should clearly plot a route of safe passage to a zero-emission economy. This route must include unambiguous and long-term legislation. The sooner governments create clarity as to how they will tackle and adapt to climate change, the better it is for financial stability. And the better financial institutions can adapt their strategy going forward. An effective carbon tax would, for example, address the problem at its root, by functioning as a direct incentive for corporations to reduce their footprint. Now, tax levies on carbon emissions vary widely across countries. From € 6 per tonne of carbon dioxide in China to € 112 in Sweden. Carbon pricing policies should be better coordinated on an international level, and should address carbon leakage and competitiveness effects. Governments were among the first to demand action on global warming in 1992. Many of them did. And they should stay ahead of the curve when it comes to taking and coordinating climate action. But in the end, we all play a vital role in tackling climate change. I believe that the momentum for climate action is now unstoppable, that the pace of change is accelerating and that even the laggards will have to jump on board sooner rather than later. After all: unsustainable means that it cannot be sustained. In other words: what is unsustainable will disappear. Investing in what disappears, rarely is a sound strategy. Three quarters of a century ago, the KfW Bankengruppe helped the German economy to emerge from the ashes of war. Now we must transform the world economy to become stable. Now we must transform our way of life to become sustainable. This transition needs the sustained effort of us all. Of governments. Of firms. Of financial institutions. Of central banks and supervisors. Because if the world is to be set on a truly sustainable footing, all finance shall become sustainable as well. Because ultimately, outside sustainable finance, there shall be no finance. Thank you. | netherlands bank | 2,019 | 9 |
Keynote speech by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, at the European Banking Federation's Banking Summit "Building A Positive Future For Europe", Brussels, 2 October 2019. | Fout! Onbekende naam voor documenteigenschap. Two issues to take on together European Banking Summit ‘Building A Positive Future For Europe’ Brussels, 2 October 2019 At the end of the first day of the European Banking Federation’s Banking Summit in Brussels, Frank Elderson gave a keynote speech. In his speech, Mr. Elderson highlighted two important topics that must be at the top of the agendas for the financial sector in the period ahead: combatting money laundering and greening the financial system. For both topics the financial community, and society at large, need to intervene collectively. Fout! Onbekende naam voor documenteigenschap. We are all here today, bankers, policymakers, supervisors and politicians alike, because we all share a common responsibility. It’s up to all of us to look to the future. To anticipate what this future may bring. And to make sure we prepare for it. I am sure the grandeur of your surroundings has not escaped your attention. Our venue today, the magnificent Steigenberger Wiltcher’s Hotel, was built over a century ago, in 1913. It was constructed in the late Art Nouveau style, as a Grand Hotel, and named after its founder, the Anglo-Belgian Sydney-Charles Wiltcher. Looking around you, you may be forgiven for thinking nothing here has ever changed. For over a hundred years. But no. This hotel became the Wiltcher’s & Carlton Hôtel, following a collaboration with the world-famous Carlton. Then in 1935, this building was converted into the offices of a Belgian pharmaceutical company. In 1993 it was renovated, and reverted to a hotel. After that it was bought by the German Steigenberger group. The hotel we are in now opened in 2015 after a two and a half year refurbishment. It is a building that has stood the test of time. And it is as impressive and as relevant today, as it was when it was built over a century ago. It was built to endure. And - with the necessary renovation - it will still be relevant in 50, 100, 200 years’ time. But can we say the same about our financial system? Will our financial system still be relevant, not only in 10, but in 50, 100, 200 years’ time? We need a financial system that is resilient to shocks. We need a financial system that is receptive to new ideas and new ways. We need a financial system built on solid foundations. We also need to renovate our financial system. And this can only happen if we act on the risks and challenges we face, now and in the near future. A little more than a decade after the financial crisis, we have made great strides in building a better capitalized and more resilient financial sector. The regulation of the financial sector is better and stronger. The capital framework has been revised with a new Basel Accord. Within Europe, the Banking Union has been created. And the Financial Stability Forum has been transformed into the Financial Stability Board, with a stronger mandate and enhanced capacity to monitor and promote global financial stability. But our work is of course never finished. If we look to the future, if only by analysing recent headlines, there are two important topics that must be at the top of our agendas for the period ahead: combatting money laundering and greening the financial system. Recent years have seen a disheartening increase in media stories about money laundering. We clearly aren’t doing enough to address this problem. The same holds true for the transition to a sustainable future. It is our collective responsibility to reduce the billions of euros in illicit financial flows to millions. And we need to turn the money needed for the transition to a sustainable financial system from the current billions to trillions. In the following I will speak about both: the need to step up the efficacy of our fight against money laundering and the need to step up our efforts to establish a truly sustainable financial system. Although both are of great importance, due to time constraints, I will dedicate most of the remainder of the speech to the former and only speak briefly about the latter. In other words, I will speak mainly about black money and only briefly about green money. On other occasions, I might turn this around. But I can only ask for your attention for so long. AML and CFT Let me start with an example. It is 2010. Mexico caps the deposits of U.S. dollars into their banks, in an effort to prevent drug cartels laundering profits. Some account holders in the Mexican city of Mexicali, some of whom may be connected with these cartels, are hit hard by this measure. They need a new place to store their money. They find it just over the border. Armored cars loaded with cash come and go at a local branch of a well-known Dutch bank in the Californian city of Calexico. Huge amounts of cash – sometimes over a million dollars carried in a simple backpack – are deposited and immediately transferred back to Mexico. The numbers at the local branch in Calexico keep on growing even faster, as many other banks around that time close down branches along the Southwest border to minimize their exposure. Based on numerous alerts, generated by the bank’s automated monitoring system, compliance officers start inquiries. But they are largely ignored by their managers. Fout! Onbekende naam voor documenteigenschap. Daily quotas for clearing alerts are imposed that prevent any meaningful investigation of flagged transfers. Two years later, at the end of 2012, the bank hired a consultancy to clarify how this could have happened. They find numerous deficiencies within the anti-money laundering program, including unqualified staff and failures to manage high-risk customers. When investigated by US officials, the consultancy’s findings are withheld by the executive managers. The story ends with the bank having to pay a settlement of $368 million to the U.S. Justice Department. The sum matches the amount of suspicious funds estimated to have flowed through the lender’s branches near Mexico from 2009 to 2012. The name of the bank at the centre of this scandal does not matter. Because far too many European banks have been shown to have significant failures in anti-money laundering controls. Recent examples of these scandals unfortunately abound. And my fear is that they are only the tip of the iceberg. The point I want to make is that dirty money is widespread and is corrupting our financial system. Money laundering lets criminals stay out of reach of law enforcement. Not only does it allow criminals to live in the lap of luxury. It also means they can plough those funds back into other illicit activities. Or maybe even to finance terrorism. I chose the Mexican example because it highlights two aspects we face in tackling this challenge. Firstly, there is the international dimension. Criminals don’t operate in a single jurisdiction. They target countries and jurisdictions where the risk of getting caught is lowest. So if we tackle these illegal activities in one jurisdiction, the criminals will switch to somewhere else. This is the waterbed effect: push it down in one place and it pops up somewhere else. Here in Europe for example, passporting allows financial institutions to serve the entire internal market from a single Member State. The second aspect I would like to underline is the sheer size of the numbers involved. Nobody knows the aggregate total of money laundering, but several conservative estimates suggest we are talking about at least 2% of GDP. This equates to roughly 400 billion euros in Europe. And almost 2 trillion euros worldwide. Money laundering and the underlying criminal activities therefore pose a genuine threat to the integrity of the financial system. Given the size and the complexity of the problem, and the enormous impact it has on our societies, I am afraid there is no quick fix. If we want to succeed in tackling this problem we need to take an integral approach based on four pillars. And I want to describe each of these pillars now. Firstly, we need rigorous compliance with existing regulations. Financial institutions need to devote sufficient time, rigor and resources to comply with these regulations. More importantly, they need to promote the right culture within their organisations. Let’s be reasonable: even without explicit regulation, banks understand that knowing your customers is part of their core business. It is key for adequate risk management, and for designing and maintaining a sustainable business case. The second pillar relates to the first. There is room for financial institutions to comply with the existing regulations in smarter and more sophisticated ways. Clever algorithms and artificial intelligence can sort through the enormous amount of ‘alerts’, and select only the most suspicious ones for further investigation. Public-private cooperation can also bring important improvements. Combining efforts and bundling of alerts by different institutions might not only boost efficiency, but could also improve our understanding of alerts. Because one alert may give us a more complete picture of the other alert. There is no need to compete in the area of security. There is ample opportunity to cooperate and thus make the system safer. In this respect, I welcome the recent announcement of the Dutch Banking Federation that the five largest banks in the Netherlands are investigating this kind of cooperation. The third pillar needs to address one major flaw in our current supervision: AML and CFT supervision is mainly organised at national level. International cooperation and exchange of information between supervisors is often too complex. It impedes the smooth AML and CFT supervision of cross-border institutions and activities. And yet, smooth exchange of information between supervisors is vital in identifying and addressing AML risks. Another flaw is that there are sometimes limited resources for this supervision. And enforcement decisions may conflict with prudential and other interests. As AML supervision is organised at national level, it fails to safeguard a level playing field. This presents the risk that precisely those members states that are most active in uncovering money laundering and terrorist financing, are also the ones suffering most from reputational damage. Fout! Onbekende naam voor documenteigenschap. Lastly, different member states implement European norms in different ways. Criminal networks target places where there is least chance of getting caught. Given their international reach, this is all too easy for them to do. A consistent and effective approach to these problems demands setting up an AML and CFT supervision mechanism at European level. Firstly, it would enable better exchange of information between supervisors, and this would give a much-needed boost to supervision of cross-border institutions and activities. Secondly, pooling supervisory resources will generate economies of scale, including increased concentration of knowledge and expertise. It would allow resources to be deployed precisely where the risks are the most significant. Thirdly, supervisory independence will be strengthened, as supervision will be further removed from local institutions and interest groups. Lastly, European supervision will help create a level playing field, as supervisory practices will become more uniform. This will greatly increase the effectiveness of our efforts to combat money laundering and terrorist financing. A European supervisory mechanism for anti-money laundering and combatting terrorist needs to cover the entire single market, and all financial sector operators. It also needs to be a mechanism with a European central supervisory authority, cooperating with national supervisory authorities. This is important because the existence of a central supervisory authority will help promote minimum standards of law and enforcement. It will also mean priorities can be set at European level. Both factors will be helpful in safeguarding the level playing field. With the involvement of national AML and CFT supervisors, adequate attention can be devoted to national aspects, and available expertise at national level can be effectively employed. This will also greatly facilitate the much needed information exchange between all parties involved. This brings me to the fourth and last pillar. When we again consider the enormous amounts involved in money laundering – 2 trillion euros worldwide, and probably more – we can only conclude that it is not enough to look at the banks and other financial institutions. They are the gatekeepers, and as such, they must do all they can to be effective gatekeepers. But in the end, let’s not forget it is the criminals who try to circumvent the gatekeepers. We should not confuse the gatekeepers with those they are trying to keep out of the financial system. The fourth pillar is about society having to become more effective in pursuing the real criminals. For this we need to take a much broader view, we need to invest in law enforcement, we need to look at our tax laws, we need to become more effective in combatting crime. So to summarize these four pillars I would say we need rigorous compliance with existing regulation. Secondly we need smarter and more sophisticated ways of cooperation between financial institutions and between them and public authorities in the field of CDD and transaction monitoring. We need a European supervisory mechanism to guarantee an effective and consistent regulatory framework. And finally we need more comprehensive public sector action, including devoting sufficient resources to prosecution, to ensure there is less dirty money sloshing through the system to start with. Climate related risks Let us now turn to our next challenge. I don’t need to tell you how our climate is changing. You can now see the impact of higher temperatures and severe weather events everywhere you look in the world. I could spend the rest of the day reciting extremely chilling examples of our ever hotter world. I will skip that. You know these examples by now. But what I would like to talk about today is how the changing climate presents substantial financial risks to the financial sector. We can divide these risks into two main channels: physical risks and transition risks. The increasing severity and frequency of climate change-related events such as flooding, droughts and storms, present physical risks that have a direct impact on the financial sector when they materialize. And then there are the transition risks. These stem from new laws and policies, technological advances or changes in public sentiment that come with the transition to a lower-carbon economy. These factors can leave carbon intensive assets vulnerable to value reassessments by financial markets. This can happen very abruptly, or could even render these assets ‘stranded’. Financial institutions with balance sheet exposures to the fossil fuel and utility sectors could particularly be affected. Fout! Onbekende naam voor documenteigenschap. That climate-related risks translate into financial risks via the physical and transition channels (and thus fall squarely within the existing mandates of central banks and supervisors) is now widely understood and accepted by an ever growing number of central banks and supervisors around the world. As Chairman of the NGFS, the central banks and supervisors network for Greening the Financial System, I’d like to tell you about our work. In just under two years the NGFS has grown significantly. From the original 8 founding members, today, the NGFS brings together 46 central banks and supervisors and 9 observers, representing five continents, representing half of global greenhouse gas emissions, responsible for supervising three quarters of the global systemically important banks and two thirds of systematically important insurers. And only last Month, during climate week, New York’s Department of Financial Services became the first U.S state banking regulator to join the Network. So we have a collective leverage that is incredibly powerful. Also the IMF joined as an observer. The World Bank, the BIS, the Basle Committee, the OECD and others had already joined before. This year, the NGFS reached another milestone: a report with six recommendations to inspire central banks and supervisors to take the necessary measures to foster a greener financial system. As said, climate-related risks translate into financial risks via the physical and the transition channels. This is not only true for climate-related risks. It also holds for broader environmental and social challenges. Water scarcity is a source of financial risk. Diminishing biodiversity is a source of financial risk. Human rights controversies are a source of financial risk. We need to think ‘beyond climate’. Financial institutions need to think ‘beyond climate’. We as a world, we as central banks and supervisors, but also financial institutions, cannot afford the luxury of worrying about climate related risks this decade, and postpone worrying about and mitigating biodiversity-related risks the decade thereafter. And the same holds true for water scarcity. Resource scarcity. Human rights. We need to look at these world-wide problems, and the financial risks they cause, in a holistic manner. Closing remarks Ladies and gentlemen, I’ve already kept you long enough. Drinks and dinner are waiting. You should start enjoying the wonderful offerings of this age-old hotel beyond just sitting here and listening to me orating about black and green money. I have addressed two topics in my speech: anti-money laundering and sustainability. These two topics share a clear international dimension. Fighting money laundering and the financing of terrorism, and enhancing sustainability, can only be properly achieved if we work closely together internationally, and at all levels. But in my opinion there is an even more striking similarity between the two topics. They are both instrumental in abiding by the key theme of this conference, that is: Building a positive future. In the case of sustainability, I would go one step further. It may be the only future we have. And certainly the only future for our children. If we want to continue our high standard-of-living, we genuinely need to integrate sustainability into all aspects of our life. This also holds true for the financial sector. All finance shall become sustainable, or there shall be no finance. And fighting illicit financial flows is also one of the main building blocks for a positive future. We need to contain the size of the black economy. This is drastically needed, to defend the rule of law and democracy on which our societies are based. To put it plainly, we need to pump the dirty money out and pump the green money in! Thank you. *** | netherlands bank | 2,019 | 10 |
Speech by Ms Nicole Stolk, Executive Director of Resolution and Internal Operations of the Netherlands Bank, at the Seminar "Financial Inclusion integrates the World", Amsterdam, 4 October 2019. | “No one left behind: a holistic approach to financial inclusion” Speech Nicole Stolk at the Seminar Financial Inclusion integrates the World 4 October 2019 Twenty-two central banks and other financial supervisors discussed the need for a holistic approach to financial inclusion at the ‘Financial Inclusion Integrates the World’ conference in Amsterdam. On the second day of the programme, DNB Governing Board member Nicole Stolk delivered a speech in which she argued that wide access, good understanding and financial resilience are the basis for turning knowledge into smart behaviour and responsible use of financial products and services. In particular, consumers must be able to cope in an increasingly digital world. While digitisation is an excellent way to connect people, there is always the danger that people with low digital literacy cannot keep up. SDGs: guiding principles for financial inclusion Today is already the last day of our seminar on financial inclusion. So now I want to share some observations with you about the progress we have made on this subject. I would like to discuss this from an international perspective. But also with a focus on the Netherlands. Imagine it’s the year 2030: the seventeen UN Sustainable Development Goals have been achieved. All seventeen of them. Imagine how our world would be then. No poverty. Zero hunger. All people equal. No more climate crisis. And the 1.7 billion adults, who in 2017 had no access to financial services. They now all enjoy the benefits of a bank account. They can get microcredit for their businesses. They have peace of mind with insurance. It is a better world for everyone. And a much better world for central banks and other financial authorities. Because supervision and macroeconomic stability should not be our only focus. We also need to turn our attention to the other major challenges of the day: the digital revolution, safeguarding data privacy, the changing climate. Everything we can do to help make our world a more sustainable place. For central bankers – but for everyone else here too – the SDGs are an excellent blueprint for achieving this sustainable world. Financial inclusion is featured as a target of eight of the seventeen sustainable development goals. For example, quality education, robust infrastructure and decent work for everyone. Financial inclusion has a big role to play in achieving the SDGs. It helps the poorest of the poor. For example, digital financial inclusion has given many women in remote rural Indian communities access to a bank account and microcredit. It unlocks new sources of income for them. Enabling them to lift themselves and their children out of poverty. I am convinced that over the next decade, we can together take substantial steps towards making these sustainable development goals a reality. Financial authorities contribute to financial inclusion Every single organization, whether in the public sector, or the private sector, should look at how it can contribute to these SDGs with their own activities. This is also what central banks do. It is the mission of De Nederlandsche Bank to safeguard a stable financial system, solid financial institutions and smoothly functioning payments. As a result of our mission, we contribute to SDGs such as decent work, economic growth and good infrastructure. Earlier this year we reviewed our strategy and priorities. We have now set out the way forward for the next five years. I'm sure you do the same at your organisation too. Our new strategy is called DNB2025. In it, we set out how we will fully integrate corporate social responsibility, or CSR, in all areas of our work. And today’s subject, financial inclusion, is of course a big part of CSR. Our new strategy means we will systematically consider the CSR impact of all our activities from now on. A holistic approach is needed to effectively stimulate financial inclusion We all know how financial inclusion can empower people so they can play a fuller role in society. When we talk about financial inclusion, we apply a broad and internationally-accepted definition. Financial inclusion is not just about having good access to the financial system, it is also about having knowledge of financial products, and improving financial resilience of people and businesses. We need all three of these dimensions to make the most of financial products and services. Only then can we – can you – make a fairer and more inclusive world. Which also strengthens financial stability on the macroeconomic level. This holistic approach is not one-size-fits-all. It varies depending on the country, culture, regions and target groups. But again, it can only be effective when all three dimensions are covered. To stress this, I’d like to quote the wise words of two pioneers of financial inclusion: To begin with, Sri Mulyani Indrawati, Indonesia’s Minister of Finance and former head of the World Bank Group: “Financial inclusion matters not only because it promotes growth. But also because it helps ensure prosperity is widely-shared. Access to financial services plays a critical role in lifting people out of poverty. In empowering women. In helping governments deliver services to their people.” To help ensure prosperity! Isn’t that exactly what central banks do? Now I'd like to read the words of Vince Shorb, CEO of the National Financial Educators Council of the United States. He stresses the importance of deploying knowledge to learn skills, and to bring about changes in behaviour: “It takes more than financial literacy to truly help people work towards a stronger financial situation. Attention must also focus on their behaviors, self-efficacy and help them develop systems to truly make a positive impact.” Again, this is clearly one of the jobs of central banks and other financial authorities! Financial and digital inclusion initiatives in the Netherlands Now I want to consider some of the practical implications. I’d like to take a couple of minutes to show you how we promote financial and digital inclusion here in the Netherlands. In the hope that you, the bright minds gathered here, get some ideas to inspire you in your own good work. Anyone with access to payment services. Anyone with a bank account. Anyone with access to mobile banking. The way is also open to them to take advantage of other financial products. For example, savings, loans or even more complex products like a mortgage or pension. That is why everyone should be able to open a payment account, preferably at a bank. Nearly all adults in a rich country like the Netherlands have a bank account. But even here it is not a given that everyone knows how to use this account properly. Or that they will be able to keep using it. That is largely down to the speed with which payment methods and other financial services go digital. For many people, this is too fast. The Dutch Consumer's Association estimates this is the case for around a quarter of the people living in the Netherlands. 2 million older people and 2 million disabled people. You can pay by card or cash, but payments with smart mobile apps are becoming increasingly popular. Vulnerable groups like the elderly, illiterate people, and people with no internet literacy, run the risk of being excluded….. also in the Netherlands. Digitisation is an easy way of connecting people, but it can also obstruct financial inclusion. The digitisation we see happening around us requires consumers to have knowledge of digital resources. The Dutch government is also aware of this. That’s why it launched a major digital inclusion project at the end of last year. Over two and half million people in the Netherlands have difficulties using digital resources. On top of this, of the 17 million people living in the Netherlands, 1.2 million have still never used the internet. That is why De Nederlandsche Bank also focuses on stimulating digital financial inclusion. We need to understand that there are two sides to digitisation. On the one hand it is an excellent way of connecting people and giving them access to the financial system. Take something like an app on your mobile that lets you safely and easily transfer money to other countries. But we also have to make sure we don't exclude people with low digital literacy. Of course, I’m not saying we need to slow down digitisation. Just that it’s very important for us to guide the digital revolution in a smart way. NFPS is committed to broad financial inclusion Now I’d like to give you a few examples of what we are doing at De Nederlandsche Bank to improve digital and financial inclusion. First, We chair the National Forum on the Payment System. This platform brings together users and providers of payment services and products from across a wide range of backgrounds. They meet regularly to discuss how to improve accessibility and availability of these services and products. Because vulnerable groups also need to be able to participate in the payment system. That way, everyone who wants to or needs to, can continue using analogue banking services instead of digital services. And to pay in cash. Second, Last year the Forum approved several measures to maintain access to financial services for the most vulnerable groups in society. This is particularly important, considering the increasing digitisation of payments, and the decline in the number of bank branches in the Netherlands. The elderly and the disabled must be able to continue carrying out basic financial tasks on their own. Banks have also been asked to put a special accessibility page on their website with an overview of how they cater to the needs of vulnerable groups. They can also appoint an accessibility coordinator. In all cases, it pays off if representatives of vulnerable groups are involved from the very start when designing new financial products and services. ERPB report to safeguard accessibility to the payment system Third: Another example of what we are doing is calling for improving access to payment systems at European level. We know all too well that you can only truly achieve something by working together. In recent years, in cooperation with the Euro Retail Payments Board, together with Age Europe, we led an informal working group with stakeholders to improve accessibility. Payment terminals, ATMs, internet payments, mobile payments and card payments. All these methods of payment have to be accessible for everyone. One particularly successful European initiative I'd like to mention is Pay-Able, a platform that strives for barrier-free access to payment terminals. Inspired by the European Accessibility Act, implemented in the Spring of 2019, we released a report outlining numerous best practices for accessibility. Many of these practices are of course focused on digitisation. The report outlines two concrete solutions: firstly, various banks have included speech technologies in their various payment apps. Secondly, an increasing number of ATMs and payment terminals use voice assistance and light and sound signals to help disabled users. And fourth and finally: I also represent DNB on the Steering Committee of the Money Wise platform. This platform was set up by the Dutch Minister of Finance and several other public and private sector organisations. Every year we carry out all sorts of projects to improve Dutch people’s knowledge of financial products. And to encourage financially responsible behaviour. Her Royal Highness Queen Máxima is honorary patron of the Money Wise platform. What we have learned is that campaigns for raising public awareness are much more effective when they fulfil two conditions. First, when stakeholders work together. And secondly if events are repeated, ideally internationally. You may already be familiar with Money Week. This is a programme of activities we put on every year to help schoolchildren learn about using cash, making card payments and encouraging them to use money responsibly. UNSGSA stimulates global financial inclusion This is just some of the work that Queen Máxima is involved in. She has also acted as the UN Secretary-General’s Special Advocate for Inclusive Finance for Development for over a decade. She focusses on two target groups in particular: entrepreneurs in need of microfinancing, and women who still do not have a payment account or good financial literacy. This is one area where Fintech can play a powerful role. Good cooperation is the key to success for financial inclusion I think I've already said this a couple of times, but it's so important I'll tell you a third time! The key to success for financial inclusion is good cooperation between all stakeholders. Across the public and private sector. A sophisticated vision and strategy can help create support and unite stakeholders. We have learned that the most successful initiatives are closely in tune with the country's culture. Initiatives need to offer public and private stakeholders the chance to join forces and discuss their vision, strategy and activities. And we can learn from each other in international fora and at seminars like this one in Amsterdam. Conclusion I've described how digitisation can be an important driver in taking financial inclusion to the next level. I've said that good access to the payments system and financial services is not something that can be taken for granted. Not even in a developed economy like the Netherlands. Where almost everyone has a bank account. The digital revolution will continue to transform our world. We must not let the most vulnerable groups in our society get left behind. So they can still enjoy access to finance. I'm sure you'll agree that this is our moral duty. By stimulating good cooperation between all stakeholders, and by doing all of this we move one step closer to a world in which the SDGs have been achieved! Thank you very much for listening. | netherlands bank | 2,019 | 10 |
Opening speech by Ms Nicole Stolk, Executive Director of Resolution and Internal Operations of the Netherlands Bank, at the seminar "Design and practice of bank resolution", held by the Dutch-Belgium IMF constituency, Amsterdam, 11 October 2019. | Fout! Onbekende naam voor documenteigenschap. “Be prepared to be flexible” Opening speech Nicole Stolk at the seminar ‘Design and practice of bank resolution’ Dutch-Belgium IMF constituency Amsterdam, 11 October 2019 On 11 October 2019 The Dutch-Belgium IMF constituency held a seminar ‘Design and practice of bank resolution’ in Amsterdam. DNB’s resolution director Nicole Stolk opened the seminar with a speech in which she summarized the Dutch experience with bank resolution within the European context. She concluded by pointing out the two challenges for resolution in the near future: engaging with the banks and close cooperation between all parties involved. Fout! Onbekende naam voor documenteigenschap. Good morning and welcome to Amsterdam. We are here today in the Presidents’ Room. If you look over to the far wall you can see that all the former presidents of De Nederlandsche Bank are watching us. At the top left is our very first President, Paul Iwan Hogguer. In 1814 he was appointed by King Willem the First of the Netherlands to oversee the creation of DNB. He was also mayor of Amsterdam at the same time! As the son of a Swiss banker and a Prussian mother, and with a brother who served as a diplomat at the Portuguese and the Russian courts, he would have appreciated such esteemed international company. As I am sure you do. One of the main goals of this seminar is to meet each other and to share our experiences. It’s good to see such a diverse range of nationalities. Most of you are from countries of the Dutch-Belgium IMF constituency. But we also have with us representatives from other jurisdictions, such as Indonesia, Egypt and Albania. There is also diversity in how you approach resolution. The different resolution regimes may of course reflect specific aspects of a jurisdiction, such as the structure of its banking sector. But each country’s approach is also shaped by its history in dealing with a banking crisis. Some jurisdictions are already at an advanced stage in developing a designated resolution function. Others are just getting started. Some, like the Ukraine, have already dealt with resolution cases in the past, while others may have little hands on experience. This seminar is aimed at high-level management, to discuss the more strategic issues. The focus is on how resolution regimes are set up, as well as the guiding principles for resolution. The banking industry operates increasingly on a cross-border basis. This means effective cooperation between regulators is vital. Meetings like this give us the opportunity to understand each other’s approaches better. So we can become better aligned at a time when the industry is not in crisis. Today we can compare the lessons learned, and listen critically and constructively to one another. And – I hope – return home with fresh ideas and new contacts. Now I will discuss our experience with resolution here in the Netherlands. Although we did not experience a real case since the establishment of the resolution regime, we have quite a lot experience in the set-up and design of a resolution function. I will describe our experiences so far from three different angles: - our history - the European context - and the challenges we face. The historical angle First, the historical angle. I already indicated that we – fortunately – have had no experience with crisis cases since we established the resolution function in 2015. This of course does not mean the Dutch banking sector is a calm landscape, as we witnessed with the full blown financial crisis of 2008 to 2010. During this crisis, the Netherlands had its fair share of crisis management experiences. And that was actually very much in the hands of Mr. Nout Wellink, depicted on the lower right hand side of the gallery. In that period, we had two bank failures, but the crisis also affected more systemically important banks and there was no resolution framework in place. The Dutch government had to support banks with taxpayers’ money. This resulted in a difficult balancing act: maintaining public confidence while retaining critical bank functions. Since then, our guiding principle has been that taxpayers’ money must never again be used to save failing banks. Losses incurred by banks must first and foremost be borne by the banks’ shareholders and creditors. This principle was actually partially applied to the public takeover of SNS Reaal in 2013, when the minister did write down on equity and subordinated debt. The Netherlands was, and still is, a very keen supporter of this “paradigm shift”, which has also paved the way for the establishment of the current European resolution regime. Although we have had no concrete cases of failure in the Netherlands since, lessons learnt elsewhere can help us improve our approach to resolution. Later during this seminar, we will analyse the few resolution cases in the EU, so we can see how the European resolution regime has been applied in practice. Ms. Rozhkova from Ukraine will also share the implications of the resolution of a major Ukrainian bank. Some authorities have experience with dry-runs and tests. I hope all of you will feel inclined to share lessons learned in the discussions of today. Fout! Onbekende naam voor documenteigenschap. The European context The second angle I want to highlight is the European context. The introduction of European resolution legislation in the wake of the financial crisis offers strong benefits. But it certainly also presents challenges. For example, is our decision-making process effective enough? Aren’t we too bureaucratic to act swiftly when needed? Achieving common policy outcomes can be complex and time-consuming. This is understandable and perhaps inevitable, given the different views and interests of Members States. But have we made enough progress to enhance resolvability since the crisis? I believe there are still some remaining issues that need further action. For example, further efforts are needed to ensure adequate levels and quality of banks’ loss absorbing capacity as well as to operationalise the resolution tools. You may have different views on this and I’d love to hear them. It would give us valuable food for thought. A second major challenge we face, is that there are still gaps in the European resolution regime itself. For instance, the absence of a more harmonised insolvency regime at the European level may hinder an effective and consistent approach across Member States. Within the European Union, placing for example a French bank into insolvency proceedings can still be completely different than in case of an Estonian bank. The principles may be the same, but the recovery and timeframes can differ. We would like to see more consistency throughout the EU in this respect. That said, in my view the benefits of a single resolution framework greatly outweigh these challenges. We now have a single framework that applies to all banks in the European Union. This really strengthens the level playing field. And on top of that, it can contribute to more effective cross-border solutions. Clearly the solution of Fortis back in 2008 serves as a bad example here, when the problems and crisis response were ringfenced across Benelux borders. The new regime ensures that resolution tools can be applied to bank which is active in multiple countries. Ultimately, we are convinced that risks to the financial sector can be mitigated more effectively as part of a joint European effort. Challenges The third angle concerns the challenges facing DNB as Resolution Authority. Here, I want to highlight two challenges that you may well recognize. The first challenge is engaging with the banks. In the early years of resolution, banks didn’t seem to take the new regime very seriously. However, in recent years the resolution perspective has become more integrated in the hearts and minds of banks. We see that resolvability has increasingly become a standard consideration in strategic decisions. Institutions need to accept that resolvability has a cost. And that the resolution authority can set requirements, which may impact their financial and organisational structure. Requirements for lossabsorbing capacity, operationalisation of resolution tools, contributions to financing arrangements: all these measures can be quite costly, but they are – as we all know – necessary to ensure effective resolution. And this is a message that banks increasingly agree to, but not without continuous efforts. The second challenge is cooperation. It is important that all our colleagues, whether they are in supervision, at the central bank, or at our Ministry of Finance, work closely with Resolution. They also have to take resolution into account in their decisions – just like banks are learning to do. However, interests and objectives may not always converge. The going-concern and gone-concern perspectives do not necessarily find common ground. So discussions between supervision and resolution can become heated. Nonetheless, these discussions also offer opportunities. Having an integrated prudential view of a bank can help anticipate crisis scenarios. It also enables more effective coordination in the phases leading up to resolution. At DNB we see a lot of these synergies, given the various combinations of tasks that fall within our mandate. I haven’t mentioned this yet, but besides being a resolution authority and a central bank, we also act as the supervisory authority, deposit guarantee authority, and macro prudential authority. All under one roof. What’s more, we have the deposit guarantee function and resolution function in the same directorate. This offers another valuable advantage, as it provides an integral view on resolvability. We will also discuss this cooperation in the fourth part of the seminar. Fout! Onbekende naam voor documenteigenschap. I have already taken a lot of your time in sharing our experiences, so let me wrap up and add one final thought. Five words that pretty much sum up resolution: Be prepared to be flexible. The essence of our job and this seminar is to be prepared for the worst. Being prepared is key for making sure resolution regimes work effectively in practice. But since we can never fully predict how bank failure will play out, a plan with no flexibility is not a good plan. Here, crisis simulation exercises are a key tool for developing flexibility. Conclusion Summing up, my three main messages this morning are: First, cooperation. Cooperation between resolution authorities, but also with other authorities like DGS’s, supervisory authorities and ministries, is key to promote an effective and consistent resolution regime. Second, preparation. Although practice will be different from planning, we can boost the chances of successful resolution action if we step up crisis preparation, while maintaining a flexible approach. This will also decrease the legal risk of resolution actions. Finally, to establish a strong resolution regime: we need to persist in our endeavours. It takes time and perseverance to overcome hesitation or reluctance, which is still present at some banks and authorities. Yet we also need to keep up our collective efforts if we really want to minimise the impact of bank failures on the real economy and society as a whole. It is fitting that the word “resolution” can also mean “will power”, or “determination”. Because these are exactly the qualities we need to overcome doubts in the sector and get everyone on board. I am sure today will produce some valuable insights which will help us all gain a deeper understanding of how we approach resolution in our respective jurisdictions. And of course, this understanding will only serve to strengthen our collective approach. Thank you! | netherlands bank | 2,019 | 10 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the fourth annual high-level conference "Racing for Economic Leadership: EU-US Perspectives", New York City, 16 October 2019. | “The quest for policy scope: Implications for monetary policy strategies” Speech by Klaas Knot at the fourth annual high-level conference Racing for Economic Leadership: EU-US Perspectives New York, 16 October 2019 In New York, at the 4th annual high-level conference on EU-US perspectives, Klaas Knot participated in a session “The Quest for policy scope”. Mr Knot highlighted implications for monetary strategies, by discussing how longer-term changes in the global economy continue to create important challenges for monetary policy. These challenges have gained in relevance over time. They should be important elements of future reflections on monetary policy strategy. More than a decade after the Global Financial Crisis erupted, inflation in the euro area has still not reached the ECB’s aim of below, but close to, 2%. This despite unprecedented conventional and unconventional monetary easing and five years of economic expansion. Moreover, market-based indicators of long-term inflation expectations in the euro area have fallen, fueling concerns that the anchoring of inflation expectations may have weakened. Against the backdrop of a weakening global economy and heightened geopolitical risks, these concerns prompted the ECB to take further measures to boost inflation at its September meeting. A lot has been said and written about the desirability of this package of policy measures. Last week the ECB published the Account of the meeting, which includes an extensive overview of the arguments exchanged in its Governing Council. Today I do not want to dwell anymore on the merits of the policy package or its individual elements. Rather, I would like to look ahead and discuss how longer-term changes in the global economy continue to create important challenges for monetary policy. These challenges relate to the controllability of inflation by monetary policymakers. I will argue that these challenges have gained in relevance over time. I therefore believe they should be important elements of future reflections on monetary policy strategy. Some of these challenges affect all central banks, while others are specific to the institutional context in which the ECB operates. Setting the stage To set the scene, let me first present two stylized facts on long-run inflation dynamics. First, low and falling inflation is not a recent phenomenon. At DNB we have performed an analysis that decomposes inflation in a time-varying trend and a cyclical component [Figure 1]. The results show that inflation has been subject to a renewed downward trend since the crisis. This differs from the episode that is known in the literature as the Great Moderation when there was no significant up- or downward trend in inflation. Figure 1 Euro area HICP inflation and its trend Percent Notes: The trend is estimated by an Unobserved Components Model of HICP inflation and the unemployment rate for the euro area, see Bonam et al. (2019). Second, not only has inflation been subject to a downward trend, but also its inertia – or persistence – has increased since the crisis [Figure 2]. After having declined gradually between the mid-1980s and the early 2000s, inflation persistence is now back at its long-term average. Figure 2 Euro area HICP inflation and its persistence percent Notes: Inflation persistence is estimated from a time-varying autoregressive model over a 30-quarter moving window for seasonally adjusted, quarter-on-quarter euro area headline inflation. The graph shows HICP inflation (in percent) together with the inflation persistence parameter. The vertical bar shows the start of the GFC. For details, see Bonam et al. (2019). The million dollar question is then what these developments signal for central banks’ ability to control inflation. Let me explain my take on this issue. Notwithstanding the ongoing debate on its validity, I still regard the Phillips curve as a relevant analytical framework to structure our thinking. According to the standard view, the Phillips curve explains the inflation process in terms of three main elements. The first element is expectations of future inflation. Expectations can be forward-looking, in which case inflation is self-equilibrating; or backward-looking, in which case inflation is more persistent. The second element is economic slack, which captures the impact of aggregate demand. While slack has traditionally been measured by an output gap or unemployment gap, recent research suggests that more granular indicators of labor market conditions are needed to better capture Phillips curve relationships in the data.1 The third element is shocks. These shocks can in principle have a positive, negative or ambiguous effect on inflation. If shocks are more permanent, inflation will be more inertial. If we look back at the euro area over the past decade, most of these shocks appear to have been quite persistent and have 1 See e.g. Aaronson, S., Cajner, T., Fallick, B., Galbis‐Reig, F., Smith, C. and W. Wascher (2014). Labor Force Participation: Recent Developments and Future Prospects, Brookings Papers on Economic Activity, Fall, 197‐255; and Bonam, D., de Haan, J. and D. van Limbergen (2018). Time‐varying wage Phillips curves in the euro area with a new measure for labor market slack, DNB WP 587, March. dampened inflation for some time. The main example here is the lower level of energy prices that we have experienced in recent years.2 Brexit can be seen as another shock that has an impact on the euro area economy, although it is not clear yet whether it will push inflation up or down. Inertia in inflation can also reflect slow moving changes in the economy, which have been at work on a global scale for some time. As documented in a recent report by the World Bank, these changes include the ongoing globalization trend, the declining bargaining power of labor, demographic changes, technological progress and the rise of e-commerce, and financial factors.3 Empirically, this inertia can be captured by a downward trend in (core) inflation.4 Now, how would this apply to the characteristics of inflation dynamics that I have just described? First, in a benign environment like the period of the Great Moderation between the mid-1990s and the early 2000s, inflation expectations were mainly forward-looking. Slack had a strong and stable link with inflation. And shocks were temporary and not very large. Also, there was no discernible trend in inflation. In this environment, monetary authorities had no difficulties in keeping inflation expectations well-anchored. In the current environment, however, inflation is low and more persistent. In a Phillips curve framework, this might reflect more backward-looking inflation expectations, more persistent negative shocks, and/or a flatter slope of the Phillips curve. But there is another interpretation as well - the Phillips curve elasticities may have remained broadly stable, while at the same time a downward trend is pushing down inflation persistently. The latter finding is confirmed by DNB research on the trendcycle decomposition that I showed you before.5 Let me stress here that I am not talking here about a secular trend that inherently lasts forever. Indeed, the model used by DNB allows for a time-varying trend. Some of the underlying factors might fade out or reverse. For example, if the ongoing surge in protectionism becomes entrenched, the trend towards increasing globalization that we have observed since the mid-1980s might actually be reversed. Hence, inflation might at some point start trending upwards again. For the moment, however, the declining trend inflation component is something we will have to deal with. So what does this environment imply for central banks? Despite accommodative monetary policy, inflation may remain persistently below the central bank’s objective for a considerable amount of time. This could undermine monetary authorities’ credibility and the effectiveness of their policies. To support credibility, central banks may therefore want to push the cyclical inflation component even harder, more aggressively easing policy in conventional and unconventional ways. As Janet Yellen 2 For a thorough analysis of this phenomenon in the euro area, see Ciccarelli, M. and C. Osbat (2017) Low inflation in the euro area: Causes and consequences. ECB Occasional Paper No 181, January. 3 Ha, J., Ivanova, A., Ohnsorge, F., Unsal and D. Filiz (2019). Inflation: Concepts, Evolution, and Correlates. World Bank Policy Research Working Paper No. 8738. 4 A thorough empirical analysis of how the changes in the global economy can be characterized by a trend in inflation is provided in Cecchetti, S., Hooper, P., Kasman, B., Schoenholtz, K. and M. Watson (2007). Understanding the Evolving Inflation Process. Paper presented at the US Monetary Policy Forum, 9 March. For a discussion of the decline in trend inflation and increase in inflation persistence in the euro area over the past decade, see Ciccarelli, M. and C. Osbat (2017) Low inflation in the euro area: Causes and consequences. ECB Occasional Paper No 181, January. 5 See Hindrayanto, I., Samarina, A. and I. Stanga (2019). Is the Phillips curve still alive? Evidence from the euro area. Economics Letters 174, 149‐152. For a discussion of these results in a broader context, see Bonam, D., Galati, G., Hindrayanto, I., Hoeberichts, M., Samarina, A. and I. Stanga (2019). Inflation in the euro area since the Global Financial Crisis. DNB Occasional Study No.3. observed in the US context, “given that inflation has been so very low for so long […] it may be necessary to have a hot labor market for inflation to move back to 2 percent on a stable basis.” But in doing that, a central bank like the ECB would face another major challenge. Eventually, these policies will run into economic, institutional and legal restrictions. Certain economic restrictions, like the difficulties associated with lowering interest rates far into negative territory, have become more relevant as a consequence of a falling natural rate.6 The scope for central banks to fight recessions by lowering short-term policy rates has likely gotten structurally smaller. While non-standard monetary policy measures can be used to ease policy further when policy rates have reached their effective lower bound, these too will eventually run into economic restrictions, when increasing side-effects start to outweigh the diminishing marginal returns of further easing. These restrictions are not unique to the ECB, and they challenge the notion that also persistently low inflation “is always and everywhere a monetary phenomenon”.7 Other, institutional and legal restrictions are more specific to the EMU. The ECB operates in an as of yet not fully complete monetary union and faces a large number of heterogeneous fiscal counterparts. It is also bound by a Treaty that explicitly prohibits it from engaging in monetary financing, the interpretation of which has been subject of debate and even litigation. The ECB, however, has stood up to the challenge. Supported by the significant strengthening of EMU and reduced legal ambiguity around the ECB’s freedom to act, the ECB has substantially widened its toolkit. Both in terms of instruments to ease the stance of monetary policy beyond the ELB, and instruments to restore impairments in the transmission mechanism of monetary policy. This has contributed to a strong recovery of the euro area economy (Figure 3). From 2013 until 2018, growth has steadily exceeded potential, closing the output gap in the process. While it is challenging to put a number on the ECB’s contribution, ECB staff analysis suggests that the monetary easing since 2014 has cumulatively contributed almost 2% to GDP.8 6 For an overview of the debate on the changing natural rate of interest and its determinants, see Bonam, D., van Els, P., van den End, J.W., de Haan, L. and I. Hindrayanto (2018). The natural rate of interest from a monetary and financial perspective. DNB Occasional Study No.3, June. 7 Milton Friedman’s much quoted proposition can be found in Friedman, M. (1963). Inflation Causes and Consequences. Asia Publishing House, New York. 8 Hartmann, P. and F. Smets (2018). The first twenty years of the European Central Bank: monetary policy. ECB Working Paper No. 2219, December. Figure 3 Euro area growth Source: Eurostat. A tangible gain has been the improvement of the labor market. Unemployment has dropped significantly and wage growth has picked up. Yet, the final step to consumer price inflation has thus far proven elusive (Figure 4). Figure 4 – Euro area wage growth and core inflation Source: Eurostat and ECB. With recent headwinds to growth dampening the inflation outlook, the ECB took further measures to support inflation. Nonetheless, given the characteristics of the inflation process that I have outlined, even now that economic slack appears largely absorbed, economists and financial markets alike see low inflation remaining persistent and converging to our inflation aim only sluggishly (Figure 5). Figure 5 – Euro area inflation expectations Inflation expectations euro area Percent, daily and quarterly data 2.2 2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 Survey of Professional Forecasters 5y Inflation swaps 5y5y Inflation swaps 1y1y Source: ECB and Refinitiv. The quest for policy scope All in all, the current situation facing the ECB is not one that was envisaged when the current monetary strategy was drawn up, back in 1998 and updated in 2003. The environment in which the ECB operates has evolved and so has the EMU’s institutional architecture. Against this backdrop, I support calls for a broad review of the ECB’s strategy, which should have as one of its main aims the widening of our policy scope. The challenges I have outlined in this talk warrant a discussion on the merits of increased flexibility in the face of external shocks. One way to achieve this would be the introduction of a symmetric band around the inflation aim, which would buy the central bank time and flexibility in responding to forces it cannot control. The monetary strategy could also be made more flexible by lengthening the horizon over which it would be desirable to bring inflation back towards its aim. Increased flexibility could help the ECB to better communicate its commitment to price stability while acknowledging its currently limited control over short-run inflation. It would also provide additional room for maneuver to prevent the built up of macroeconomic and financial imbalances, which – at the moment they collapse – might cause an even more severe ELB situation.9 9 Borio, C. (2018). Looking through the glass. OMFIF City Lecture, London, 22 September. Of course, longer deviations of inflation from its aim pose communication challenges, and might cause a drift in inflation expectations. Also from this perspective, a symmetric band around our inflation aim would have merit. It would acknowledge that sometimes inflation will over-, while at other times it will undershoot. More explicit forms of ‘make-up’ strategies have been put forward too, for example by former FOMC Chair Ben Bernanke.10 These strategies explicitly aim at an inflation overshoot following a period of inflation below target. To the extent that such strategies bring us back to a very precise aim for average inflation, I fear, however, that they might end up limiting our flexibility rather than enhancing it.11 Last but not least, the ECB does not operate in a vacuum. Whichever way central bankers will decide in designing a new monetary strategy, perhaps the most important precondition to preserve policy scope is that other policies also contribute to macroeconomic and financial stability. In the euro area, important steps in this regard have already been taken. The ECB’s scope to ease its monetary stance has benefited greatly from the improvements to EMU’s institutional architecture. Yet, it is a fact of life that the ECB still faces 19 different fiscal counterparts. This makes the purchase of government bonds more fraught than in other jurisdictions. Time-inconsistent application of the Stability and Growth Pact and the absence of a central fiscal capacity have also contributed to fiscal policies not having been as countercyclical as in other advanced economies12. I would see merit in a simpler Stability and Growth Pact, with perhaps more emphasis on debt levels relative to budget deficits. To what extent this should be complemented with steps towards more fiscal risk sharing, is very much a political question. From my perspective, I can only note that more effective fiscal stabilization would have the potential to make the ECB’s job significantly easier. And that offers a nice bridge to the next speaker, who will undoubtedly dwell on this subject more extensively. I thank you for your attention. 10 See e.g. Bernanke, B. (2017). Monetary policy in a new era. Brookings Institute, October. 11 For a more extensive discussion on the pros and cons of make‐up strategies, see e.g. L. Mester (2018). Monetary Policy Frameworks. Panel Remarks at the session on "Coordinating Conventional and Unconventional Monetary Policies for Macroeconomic Stability", Allied Social Science Associations Annual Meeting, Philadelphia, PA, 5 January. 12 See e.g. European Fiscal Board (2019). Assessment of EU fiscal rules, August. | netherlands bank | 2,019 | 10 |
Opening remarks by Mr Klaas Knot, President of the Netherlands Bank, at the panel "The Advanced Countries: Economic Challenges for the Medium Term" during the G30 34th International Banking Seminar, Washington DC, 20 October 2019. | Fout! Onbekende naam voor documenteigenschap. Opening remarks by Klaas Knot at the panel “The Advanced Countries: Economic Challenges for the Medium Term” during the G30 34th International Banking Seminar Washington, 20 October 2019 On 20 October 2019, one of the panel sessions at the International Banking Seminar was called ‘The advanced countries; Economic Challenges for the Medium Term’. Klaas Knot was asked to deliver a short opening statement. In it, Mr Knot focussed on the challenges the Economic and Monetary Union faces over the medium term, concluding with three concrete recommendations. Fout! Onbekende naam voor documenteigenschap. I would like to start by thanking the organizers of the Group of Thirty for the chance to participate in this panel. In my introduction, I will focus on the challenges the Economic and Monetary Union faces over the medium term. Let me start by saying that the concept of the ‘medium term’ is an intriguing one. From a political perspective the medium term is a place where one kicks the proverbial can to. From a monetary policy perspective, on the other hand, problems in the medium term would typically be cause for immediate action. This asymmetry in policy reactions might be at the core of the institutional frictions facing the Economic and Monetary Union since the global financial crisis. The twenty years since the formation of the Economic and Monetary Union can be divided into two very different periods. The first decade was characterized by stable inflation and economic growth. In the second decade, our Union has faced a continuum of economic challenges, the seeds of which had been sown during the first decade of apparent stability. In this light, important design flaws of our monetary union have come to the fore. These design flaws left the EMU prone to the build-up of macroeconomic and financial instabilities and left it insufficiently resilient to shocks. The fact that half of the EMU’s existence has been defined by these challenges has taken its toll on the public support for further European integration, but for not the euro. And although the clearest manifestation of this backlash is visible outside of the EMU in the form of Brexit, within the euro area the appetite for further far-reaching reforms is at a rather low point as well. This is not surprising if we look back and see how fast, sometimes contentious measures had to be implemented, in response to the sovereign debt crisis. Strengthening of the fiscal rulebook and the introduction of the European Stability Mechanism were big steps towards further EMU integration. However, in a semi-permanent mode of crisis-management, policy makers had little to no time to involve their constituencies. The magnitude of the euro area debt crisis was amplified by the fact that channels through which macroeconomic stabilization could take place, were insufficiently developed. As a result, a large part of the adjustment burden was placed on monetary policy. The interventions of the ECB have bought time to enhance the institutional framework and for individual member states to implement much needed reforms. The question however is, has this time been put to a sufficiently productive use? I am afraid that asking the question boils down to answering it. The underlying economic performance clearly suggests this not to be the case. Since the start of the EMU, convergence was visible between high- and low per capita income member states. When taking a closer look, however, we see that real convergence before the crisis was mainly based on the activation of more production factors, in particular in terms of an inflow of external capital flows into the euro area periphery. Developments in total factor productivity, on the other hand, had negligible impact on the convergence of real per capita income. As we know from economic literature, productivity growth is indispensable for sustainable GDP growth. After all, it is the only source of sustainable increases in prosperity. But the inflow of foreign capital had mostly stimulated activity in less productive, non-tradeable sectors, including real estate. When these macroeconomic imbalances adjusted during the crisis, real convergence largely reversed. Whereas now, after the crisis, real convergence has resumed in some parts of the euro area, we see that this reflects mostly a recovery in labor markets, while the cross-border flows of capital have stagnated and there are again few signs of a more efficient allocation of production factors. This suggests that member states are still not reaping the full benefits of their participation in EMU and may leave their economies again vulnerable to shocks. In this light the recent slowdown in euro area activity, albeit largely caused by external trade shocks, is a firm reminder: further strengthening of EMU is necessary. Without additional action, once more monetary policy will risk ending up as the only, and perhaps stuttering, engine supporting growth. Against this backdrop, I would like to finish my introduction with three recommendations, which I believe should be prioritized. Fout! Onbekende naam voor documenteigenschap. First, private risk-sharing between member states should be strengthened. This involves completion of the Banking Union, by means of a European Deposit Insurance Scheme. Furthermore, I look forward to new European Commission’s proposals to move towards a Capital Markets Union. The potential contribution of these initiatives is multifaceted. In successful monetary unions they bear the brunt of any adjustment to asymmetric shocks, thereby relieving the burden from public sector stabilization policies. They will foster more efficient and sustainable cross-border financing flows, that will support potential growth throughout the euro area. And they will contain the risk of future imbalances. My second recommendation: it would be beneficial if future monetary and fiscal policy would, more so than in the past, move in the same direction. There is mounting evidence that monetary policy can reach it goals faster and with fewer side effects if it is aligned with fiscal policies. The combination of a unidirectional fiscal and monetary policy reaction to changes in economic conditions, can create an environment where both public and private investment can bolster economic recovery and support the growth potential. And thirdly, I should note that, at least at the current juncture, the EMU’s design remains a compromise between limited risk-sharing and a large degree of individual control and hence accountability. This implies that member states will remain subject to market discipline. And this places a distinct responsibility on the shoulders of member states, to create the preconditions that enable their economies to flourish within the EMU framework. Judging by various measures of economic competitiveness, including ease-of-doing-business and strength of the legal system, structural and institutional reforms remain necessary to stimulate potential growth. So in short, it is all about addressing institutional imperfections within EMU, improving the consistency between fiscal and monetary policies and kick starting structural economic reforms in member states. Notwithstanding the political intricacies of these issues, they can only be solved with credible commitment from public policy makers. Such commitment would enable the EMU to start reaping the economic benefits today from solving the issues that we know we will be facing tomorrow. Or in terms of the proverbial can: picking it up today will save us cleaning up an undoubtedly bigger clutter in the future, while living in a tidier place in the meantime. And on that positive note I would like to end my introduction. *** | netherlands bank | 2,019 | 10 |
Dinner speech by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, at the FRBSF conference "The economics of climate change", San Francisco, 8 November 2019. | Fout! Onbekende naam voor documenteigenschap. “Discussing financial risks during wildfire” Dinner speech by Frank Elderson at the FRBSF conference “The Economics of Climate Change” San Francisco, 8 November 2019 At the conference ‘The economics of Climate Change’ the San Fransisco FRB invited Frank Elderson for a keynote dinner speech. Frank Elderson, chair of the NGFS and board member of De Nederlandsche Bank, showed how climate change – as a twofold driver of financial risk – is a serious topic for NGFS members around the globe. Fout! Onbekende naam voor documenteigenschap. The smell was inevitable. The smell of smoke. The smell of wildfires. I have been to your beautiful state before. I remember seeing the magnificent Golden Gate Bridge rising up out of the San Francisco fog. But now in Europe and around the world we see images of the bridge shrouded not in the famous fog, but in a smoky haze. And this smoke is so heavy that you can’t only see it. You can smell it, even taste it. And it is the smell of an omnipresent catastrophe. Behind this smell are stories of despair. It is the smell of the burning vineyards and buildings of the historic Soda Rock winery, which stood for 150 years. It is the smell of Marcella and James Shirk’s home going up in flames, which they had lived in for the last 42 years. It is the smell of fire threatening the Rivas family home again. The same home they watched burn two years ago and painstakingly rebuilt. It is the smell of the smoke that has kept schools across the state closed for days and sometimes weeks. Interrupting the education of one in six children in California. It is the smell that has prompted enforced power outages, leaving thousands of families and businesses without power. It is the smell of entire destroyed communities, built on the wildland-urban interface because it is too expensive to build in town. Of course, not counting the terrible mental anguish, there is also the heavy economic price to pay. Because the vineyard that has burned to the ground, next to providing us with the beautiful Californian wines we are probably drinking right now, provides work and attracts tourists. The elderly couple whose home has burnt to the ground don’t have enough money for their retirement. The family whose house is threatened can’t afford the insurance premiums. And even if they decide to sell their house and leave, who will buy it? Every time the school closes, parents have to stay at home and can’t go to work. And even if they work from home, how are you supposed to do that when you have no power? The financial losses from these fires are staggering — some estimates put them at $400 billion in 2018, or almost a seventh of the state’s gross domestic product. Financial risks A report by the insurer Munich RE found that the Camp Fire was the costliest natural disaster in the world in 2018 at $16.5 billion. The world's largest reinsurance firm blamed global warming for $24 billion of losses in the California wildfires. It warned that insurance firms will have to raise premiums to cover rising costs from extreme weather. That could make insurance too expensive for most people. And insurance firms - as we know - form the buffer we as a society installed for unforeseen or toolarge-to-cope-with-catastrophes. We can see them as the economy’s shock absorbers. And if there’s nothing to absorb the shocks, the system is in real danger. Extreme weather and its effects will of course not only affect insurance companies. The value of credits and investment of financial institutions at large in this area also vanished in the flames. So these wildfires, and the devastation they cause to lives and property, are unequivocally drivers of financial risk. And this direct effect of the changing climate can occur via comparable channels too: strong winds and tornadoes can tear down buildings, heavy rain and hail storms could devastate greenhouses and crops and rising sea levels as well as droughts could endanger whole communities. You see, we’re getting to the point now where I should make clear why I’m enumerating what you probably already know. Both the reason we’re gathered here and the reason I started with these facts: Leaving aside the terrible human cost… It’s about money. It’s about financial risks. Financial risks for the inhabitants of your beautiful state, financial risks for the insurers, financial risks for small businesses and the banks who lend to them, financial risks for local authorities. In the same way that this smoke spreads to all counties in the state, these risks can spread to all corners of the economy. And this is but only one way the changing climate can be a driver for financial risks. Next to the physical risk that climate change is causing, there is also a transition risk channel. Fout! Onbekende naam voor documenteigenschap. As governments have prime responsibility for climate policy, not all but many of them all over the world are developing new regulations to transition to a low-carbon economy. Have financial institutions properly priced in all the effects of new rules and regulations? Financial institutions have significant exposures to companies that emit high levels of CO2. Financial institutions such as pension funds and banks, are vulnerable to their carbon-intensive assets suffering a sudden loss in value. Here again, risks are already unfolding. A good example is Dutch legislation in the real estate sector. From 2023 onwards, office properties in the Netherlands will be required to have an energy efficiency label of at least C, resulting in stranded assets, in the form of those offices with an energy label lower than C. Policies like this prompt institutions to hold a mirror up to themselves, to take stock of the assets they hold and how their value will be affected by future climate policies.To us, in the Netherlands, in Europe, and many other places around the world, facts like these have made us consider that climaterelated financial risks and their drivers are of primary concern for central banks and supervisors alike. This might seem trivial to you now, especially after the presentation and discussions we heard today. But it has not been an easy road, connecting the dots between finance and climate change. We all felt this was a thing worth doing. Yet this was not an easy thing. It was not easy to convince our colleagues that climate change was a word that central bankers should even have in their vocabulary. It was not easy to convince our banking supervisors that they should discuss climate related risks with the banks under their supervision. It was not easy to persuade our European colleagues to include climate risk in the ECB’s risk map. It was not easy to hammer home the fact that climate risks are also very real financial risks. And look where we are now. A large group of central banks in the world have woken up to the need to align finance with sustainability. Here I stand as the first chair of the Central Banks’ and supervisors Network for Greening the Financial System. The NGFS. We started as a small scale initiative of the Banque de France with eight central banks, five from Europe and other members from China, Singapore and Mexico. In just under two years we have expanded to almost 50 members. 48 to be precise as of today. And not only central banks and supervisors, but also international and standard-setting bodies like the Basel committee on Banking Supervision and IMF are on board as observer. As are the World Bank, the OECD, the BIS. Last month, the NY State Department for Financial Services joined, and this week IOSCO. The Network now spans five continents, representing half of global greenhouse gas emissions and with responsibility for supervising over three quarters of the global systemically important banks and two thirds of systemically important insurers. So we have a collective leverage that is incredibly powerful. What the network does? Our mission is very clear: to exchange experiences, share best practices, contribute to the development of environmental and climate risk management in the financial sector and to mobilize mainstream finance to support the transition toward a sustainable economy. It’s been less than two years since we laid the first stones of the NGFS. But in that time the network has grown from strength to strength. A year ago we published a first progress report in which NGFS Members acknowledged that climaterelated risks are a source of financial risk and with that, it falls squarely within their existing mandates to work on this. The second big milestone was the report “A call for Action” which we published last April. We issued recommendations to provide all central banks, supervisors and the financial community with deliverable goals that will help to ensure a smooth transition to a low-carbon economy. Our first – core - recommendation is to integrate the monitoring of climate-related financial risks into day-to-day supervisory work, financial stability monitoring and board risk management. Supervisors are encouraged to integrate climate related risks in their supervisory framework and assess strategic resilience of their firms to climate change policy. Firms are encouraged to take a long-term, strategic approach to the consideration of these risks and to embed them into their business-as-usual governance and risk-management frameworks. Fout! Onbekende naam voor documenteigenschap. Second, lead by example, specifically central banks are encouraged to integrate sustainability into their own portfolio management. This is about practicing what we preach and we already took action. Two weeks ago during the Annual Meetings in DC we published a guide on Integrating Sustainable Responsible Investment in Portfolio Management. Other recommendations are on the data gaps and capacity building. We need to collaborate to bridge the data gaps to enhance the assessment of climate-related risks. Public authorities should share and if possible make publicly available any climate-risk data. Fourth, build in-house capacity and share knowledge with other stakeholders on management of climate-related financial risks. An important element to achieving effective consideration of climate risks across the financial system is to support internal and external collaboration. The success of these recommendations relies on two important factors, which lead to two broader calls to action on disclosure and classification of climate-related financial risks. First, to support the market and regulators in adequately assessing the risks and opportunities from climate change, robust and internationally consistent disclosure is vital. The market and policymakers must continue to work together to determine the most decision-useful metrics for climate-related financial disclosures. Second, we encourage regulators to develop an adequate classification system – a taxonomy - to identify which economic activities contribute to the transition to a green and low-carbon economy. This taxonomy is not only essential for the financial sector. Will it also be useful for central banks’ monetary policy? Ms Christine Lagarde, the newly appointed president of the ECB, recently said that once a taxonomy is agreed upon, the ECB will need to assess whether and how it can apply to the ECB’s Purchase Program APP. Actually putting climate-related risks on the agenda and coming to these recommendations, maybe has been the easy part. Now we come to the hard part. As I said, it is still a challenge to get our hands on quality, transparent and disclosed data. Eventually we aim to translate the ‘exposure at physicaland transition risks’ into PDs (probability of default), LGDs (loss given default), and finally into expected- and unexpected losses. There are various initiatives that try to close this gap, originating from both supervisors and the private sector and we definitely are making progress, but it still remains a challenge for us. That’s why we need to keep up our efforts. Our next steps will be to publish further technical documents: - a guide for supervisors on how to supervise climate-related risk - a guide on Environmental Risk analysis for the sector - and research on whether there is evidence for a green-brown differential including development of high-level scenarios for supervisors and central bankers We recognise that the challenges we face are unprecedented, urgent and analytically difficult. The stakes are undoubtedly high, but the commitment of all stakeholders in the financial system to act together on these recommendations will help – as Mark Carney from the Bank of England put it - avoid a climate-driven “Minsky moment”. We need to be at the point where central banks and supervisors see scenario analysis and stress testing of these risks as a given. The point where the board and senior management of institutions engage in managing these risks, not because we tell them to, but because it’s a fundamental part of their prudential responsibility. Opportunities So yes, the gloom and stories of despair may continue if we do nothing. But all over the world people, institutions, governments and companies are stepping up to the plate. Because we need to. And because with change, comes opportunity. Opportunities for businesses and professionals. Many of these opportunities have already been seized, especially here, despite – or thanks to? –the fact that the wildfires blaze and herald the need to change. California, the world’s 5th largest economy, is a global leader in climate change mitigation efforts with bold climate goals and actions. Its climate goals include: - reducing greenhouse gas emissions to 40 percent below 1990 levels by 2030 Fout! Onbekende naam voor documenteigenschap. - providing 100 percent of the state’s electricity from clean energy sources by 2045 reducing methane emissions and hydrofluorocarbon gases by 40 percent and adding 5 million zero-emission vehicles to California’s roads by 2030 Renewable energy in California has matured: Solar and wind are cost-competitive with fossil fuels. California is the clear leader in clean tech patent registration in all major clean technology categories. For every one patent registered in Texas, the state with the second-most patents registered in 2018, California had 3.5 patents. And 58 percent ($3.4 billion) of all US investment in clean technologies was invested in California. Innovations from industry large and small are helping us to mitigate these dangers and transform our economy. And of course it is not only the state of California that is stepping up: it is estimated that by 2021, one quarter of total store sales in the U.S. ($150 billion) will be sustainable products. The number of companies across the world who issue some form of sustainability report continues to increase. Sustainability reports are now issued by 94% of the world’s 250 largest companies. And this month the issuance of green bonds burst through the $1tn mark worldwide. Not only is there a rising volume, the demand still exceeds the supply. When the Dutch Government issued its first sovereign green bond last May, it was the first country with a triple A rating to do so and it was many times oversubscribed. The green bond market currently constitutes under 1% of the total bond market. So we can clearly state that a lot has been done. And there is still a lot to be done. So every small and private initiative is worthwhile. Every initiative by a US state is valuable. Every global action can really make a difference. So let us focus not on the stories of despair, but on the silver lining: Focus on the steps we are already taking to protect our financial system from catastrophe. And if we need any inspiration - what better example do we have than the brave men and women who together form the fire service? The teams of first responders who run towards the smoke, while everyone else runs away. Their heroic sacrifice. Their unwavering commitment to the noblest of causes: protecting people’s lives, their homes, their businesses and even our artistic heritage from devastation. As custodians of the financial system, how can we follow their example? How can we emulate them? We are lucky we don’t have to put our lives on the line. But everyone here today can take inspiration from these heroes. Cooperating as a team in their unfaltering dedication. Their adaptability to new and deadly risks. Their tireless singularity of purpose, in the diversity of their team. Their willingness to stand in the way of impending catastrophe together. And their resolve to never give up, until the job is done. That’s the mindset we need. That’s the dedication we need. That’s the cooperative spirit we need. I cannot think of a more fitting example to follow for us as the financial system’s fore department: to stand together when crisis hits, and to do all we can to prevent it. Thank you. | netherlands bank | 2,019 | 11 |
Keynote speech by Mr Klaas Knot, President of the Netherlands Bank, at the European Banking Institute Policy Conference "Banking in Europe; a political, a monetary and a supervisory perspective", Frankfurt am Main, 14 November 2019. | “Knowns and unknowns of monetary policy instruments: implications for monetary policy strategies” Keynote speech by Klaas Knot at the EBI Policy Conference ‘Banking in Europe; a political, a monetary and a supervisory perspective’ Frankfurt, 14 November 2019 At the European Banking Institute’s policy conference of 14 November Klaas Knot was invited for a keynote speech. In this speech, Klaas Knot stated that our knowledge of unconventional monetary policy tools is still less developed than our understanding of conventional interest rate policies. In line with his recent endorsement of the call for a formal review of the ECB’s monetary policy strategy under the new ECB-presidency, he invited the audience to be the cartographers of the ocean of the yet uncharted monetary policy. Ladies and gentlemen, Thank you for the invitation to hold this keynote address. We are drawing closer to the end of the year in which the ECB has been celebrating its twentieth anniversary. Typically, this type of event leads one to look back and reflect on the lessons learnt over time. And to evaluate how the lessons learnt can be taken on board in future endeavors. Indeed, the year has seen many conferences and papers dedicated to the tale of the ECB’s first two decades. For European central bankers, the second of these two decades has been particularly challenging. In the last decade, the ECB has been navigating uncharted waters with unconventional monetary policy, just like Magellan, Sir Francis Drake and Columbus. We were not without compass, nor without a clearly set course. But nevertheless, the waters we navigated were new to us. No maps were available. And, again like those famous explorers, we were vigilant, alert and prudent. Now that we seem to have reached a harbor of some sort, and a new captain is aboard, we should consider charting the unchartered. We should draw maps of the coasts we discovered. We should mark where the sea monsters live. We should be the cartographers of unconventional monetary policy. For such reasons, I have recently endorsed the call for a formal review of the ECB’s monetary policy strategy under the new ECB-presidency. In a speech in New York last month, I discussed in this context the challenges arising from incomplete control of the variable that is of our main interest; which is, of course, inflation.1 Today, I want to reflect on the role of the unconventional monetary policy instruments that have been deployed to deal with the global financial crisis and its low inflation aftermath. At the start, the use of unconventional tools very much came down to learning on the job. Most of the instruments were new when they were introduced and beforehand their effects were to a large extent unknown. The uncertainty was also due to the difficult circumstances in which central banks had to operate: financial intermediation was impaired and inflation dropped significantly below our aim of below but close to 2%. To address this, central banks started communicating more clearly on future policy rates, took policy rates into negative territory and engaged in balance sheet policies to complement conventional policy rate cuts. Now, after a decade of experiences and new academic research, we definitely know more about unconventional monetary policy tools. For one, all of our measures have contributed to a significant easing of financial conditions, thereby supporting the euro area economy. Yet, inflation has remained below our aim for an extended period of time. As I have argued in New York, in my view this can be largely ascribed to increased persistence of the inflation process and a declining trend in some of the underlying components of inflation. Not so much to a lack of accommodative financial conditions to which all of our instruments continue to contribute. All lessons learnt, I will argue today that our knowledge of unconventional monetary policy tools is still less developed than our understanding of conventional interest rate policies. Our newly developed analytical tools tell us that unconventional measures have effects that derive largely from specific circumstances. Or, as economists say: “their impact is state-dependent”. The effects of unconventional “The quest for policy scope: Implications for monetary policy strategies”, speech at The fourth annual high-level conference Racing for Economic Leadership: EU-US Perspectives, New York, 16 October 2019. instruments depend on the situation and therefore can also differ over time. For policymakers the key challenge then is to assess which circumstances - or states - apply, before deciding on the most appropriate set of instruments to deploy. In the real world and in real time, policymakers will face uncertainties when making this assessment. The question on how to deal with these uncertainties should feature prominently in an upcoming evaluation of the ECB’s monetary policy strategy. I will posit that policymakers should consider applying more caution in deploying unconventional instruments that are subject to more uncertainty, while acting more forcefully with conventional instruments where our knowledge is more developed. When monetary policy works To explain in more detail what I see as the main uncertainties with respect to unconventional monetary policy tools, let me first step back just five years in time, by quoting former Fed Chair Ben Bernanke. He famously quipped that balance sheet instruments, such as QE, work in practice, but not in theory.2 Indeed, central banks implemented unconventional monetary policy instruments at a time when the workhorse macroeconomic models could not be used to assess their expected impact. The models typically had a zero lower bound on interest rates, excluding the possibility of a negative nominal policy rate. Modelers struggled with a “forward guidance puzzle”, which implied that communication on future policy rates had implausibly large effects on the economy. And last but not least, financial transmission channels like the ones that pass-through the banking sector were poorly modelled. Since Bernanke’s quote, a burgeoning academic literature has increased our understanding of them. We now typically talk about the effective lower bound of policy rates, which can be below zero. Models with incomplete information now show that forward guidance is useful, although not almighty. The modelling of the financial sector is more advanced. Furthermore, academic research has mapped out the circumstances in which balance sheet policies can have an impact on the economy. So we can now conclude that they can have an impact in practice and in theory. That being said, the exact circumstances in which balance sheet instruments are effective warrants some further detail. In the last decade many different types of balance sheet instruments have been implemented by central banks. The literature tells us there is one feature that binds them: frictions in financial markets that imply imperfect asset substitutability or market segmentation. These frictions are crucial for these instruments to have an impact on financial conditions. Such imperfections can be thought to exist between any two types of assets, giving rise to different risk premia, such as a term premium on long-term bonds, a risk spread on corporate bonds and a liquidity or safety premium on liquid and safe bonds. These frictions shape the impact of central bank interventions on financial conditions. The main message from the theoretical literature on central bank balance sheet policies is that central banks can alleviate financial frictions by intervening directly in financial markets. By increasing its role as an intermediary, a central bank can effectively suppress risk premia, which leads to an easimngof financial conditions for households and firms.3 This is actually what we have observed in practice. However, there is an important catch: the relevant frictions may not only emerge as a consequence of temporary market Bernanke, B (2014), “A Conversation: The Fed Yesterday, Today and Tomorrow”, The Brookings Institution, 16 January. See for instance Gertler and Karadi (2015), Monetary policy surprises, credit costs, and economic activity, American Economic Journal, 7(1), 44-76. disfunctioning, but they may also reflect more structural underlying problems, that monetary policy measures cannot resolve. These considerations have also been highlighted in a recent report of the Committee for the Global Financial System.4 It provides an extensive overview of the international experiences with unconventional monetary policy tools since the crisis. A main message of the report is that “a proper design and sequencing of unconventional monetary policy tools depends on the origins of the shocks affecting the economy. Different shocks disrupting the monetary transmission may require different monetary policy tools. Consequently, unconventional monetary policy tools are more effective if they are tailored to the structure of the economy, the legal and institutional specificities in a particular jurisdiction, and the economic shocks prompting their use.” This is a comprehensive summary of what to think of what economists refer to as state-dependency. Some situations present larger challenges for central banks than others. The CGFS-report flags that policymakers should be conscious of the potential risks that are entailed in a prolonged use of unconventional monetary policy tools. These could be political economy concerns, as well as the implications for moral hazard in the private and public sectors and for financial stability more generally. In this regard, I agree with the report’s conclusion that unconventional monetary policy tools are more effective when accompanied by appropriate supervisory, prudential and fiscal policies. Challenges in the EMU context In the EMU, the financial frictions that determine the effectiveness of balance sheet policies are subject to one further intricacy. We are a monetary union of sovereign states without a euro area wide common safe asset and where government debt is issued at the national level. As such, we are facing 19 issuers of sovereign debt, implying a total of 19-1=18 sovereign risk premia. Additionally, at the height of the euro area debt crisis, and, as a consequence of the sovereign-bank nexus, some jurisdictions were confronted with a risk premium associated with the possibility of that member state having to leave the euro: so-called redenomination risk. This made it clear that in the EMU, financial frictions may emerge along national lines. Those frictions also reflect underlying macroeconomic differences at the national level, or heterogeneity in financial structures. While, in theory, this provides the ECB with a wide range of options to influence financial conditions, it also complicates the identification and the nature of shocks. Shocks may for instance emerge from euro area-wide changes in risk-sentiment. But shocks may also originate from national structural weaknesses. If the central bank would respond to the latter, it intervenes in areas where other players have a responsibility to act. This highlights an important dilemma for monetary policymakers. On the one hand, central banks may see a need to intervene to provide more policy accommodation. But, on the other hand, by doing so they may prolong or even exacerbate underlying problems. Lessons learnt for monetary policy strategies I have argued that every challenge and situation calls for its own unique assessment and specific set of instruments. Against this backdrop, central bankers will not be able to give you an exhaustive list of what CGFS (2019), Unconventional monetary policy tools: a cross-country analysis. instruments should be used in case of all potential future contingencies. However, I do think that, so far, our experience with the new measures has taught us some broader lessons that are relevant for future monetary policy strategies. One key lesson is that central banks can act forcefully on those fronts where our knowledge is most developed. First, this concerns the conventional monetary policy tools. The ECB has demonstrated that zero is not the effective lower bound for the policy rate. Needless to say, uncertainties and challenges remain. While policy rates can go below zero, they may hit what has become known as the reversal rate5: the level of the interest rate below which the negative effects on the banking sector start outweighing the positive effects. In that situation, lowering rates further may actually imply that monetary transmission becomes impaired. An environment that policymakers do not want to venture in. Second, central banks can act forcefully in an environment in which shocks and frictions in the economy can be clearly identified. By reducing the term premium and credit spreads in bonds markets through asset purchases, central banks have significantly eased financial conditions. The extended monetary policy interventions by the ECB taken in the aftermath of the sovereign debt crisis, have removed most financing constraints for borrowing and spending by firms and households. This has supported aggregate demand. At this juncture, one might argue that financial conditions are not really an impediment to economic activity and for inflation to increase. Third, unconventional monetary policy measures are effective if other policy areas contribute decisively to solving underlying structural problems in the economy and financial sector. This can, for instance, prevent that the monetary transmission mechanism loses its efficacy by a lack of capital or the persistence of legacy assets on banks’ balance sheets. Resolving those issues can, for example, reinforce the effects of the targeted long-term refinancing operations that the ECB is offering to banks to support the supply of credit at the present juncture. Having said this, monetary policy may wish to display more inertia – by which I mean caution or carefulness - in deploying policy instruments on those fronts where our knowledge is less developed. This applies to less conventional policy tools, of which the effects are still not fully appreciated, both in phasing-in and the phasing-out. A more inert approach by the central bank is also warranted if the nature of shocks and frictions in the economy cannot be clearly identified. Frictions may reflect structural underlying weaknesses in economies or the banking sector, of which the root cause cannot be addressed by monetary policy. A cautious monetary policy response is also appropriate, if there is a risk of complacency in other policy areas. For example when monetary policy measures lead to delayed efforts to shore up bank balance sheets or implement structural reforms at the national level. The EMU perspective The dilemma on when to act forcefully and when to apply caution in a context of instrument uncertainty is of clear relevance for central bankers worldwide. Policymakers should consider to apply more caution in deploying unconventional tools that are subject to uncertainty, for example because their effects depend on shocks and frictions that cannot be clearly identified in real time. Given the intricacies of Brunnermeier and Koby (2018), The reversal rate, NBER Working Paper No. 25406. monetary policy in a monetary union, I believe this may be of particular relevance in an upcoming review of the ECB’s strategy. At the same time, in the ECB’s case, we can draw comfort from the enhancements in the functioning of EMU that have been implemented in the last decade. This includes the establishment of the European Stability Mechanism, the European Banking Union and first steps towards a Capital Markets Union. These institutions contribute to align the incentives for action and the policy measures of other players with those of monetary policymakers. This will reduce the dilemmas for the central bank to employ balance sheet instruments. Their use can then be tailored more easily to circumstances where they are most effective. In that sense, it is clear that monetary policy in the euro area is helped by further steps to move to a more complete economic and monetary union. And speaking about European institutions: imagine what maps Sir Francis Drake, Vasco da Gama and Columbus could have drawn when we would have cooperated. In their times, Sir Francis Drake explored for Elizabeth I of England and for her alone. Vasco da Gama carefully drew maps of his trip round Cape Horn for the Portuguese king only. And Cristopher Columbus, a native of Genoa, was hired by and thus worked solely for the Spanish King and Queen. But we, you, brave explorers of the monetary policy waters, we work together. We can combine our lessons learned. We can together combine our sketches and work on one clear map. Let’s be the cartographers of the ocean of the uncharted monetary policy. | netherlands bank | 2,019 | 11 |
Keynote speech by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, at the European Insurance and Occupational Pensions Authority (EIOPA) 9th Annual Conference, Frankfurt am Main, 19 November 2019. | “Are we doing enough?” Speech by Frank Elderson at EIOPA 9th Annual Conference 19 November 2019 At EIOPA’s 9th annual Conference, Frank Elderson was asked to present a keynote speech. In this speech Elderson explains how climate change impacts insurance companies and pension funds. He also describes the efforts the different parties in the field have taken, in order to discuss whether these efforts are enough. This year, 2019, has been a year of great momentum. No time to sit back, but we must take some time to look back and see how far we have come. EIOPA has come a long way in addressing climate and sustainability. And I would like to commend EIOPA, under the leadership of Gabriel Bernardino, for this. It is encouraging to see how much progress we have made. This needed all hands on deck. Not only from the financial sector, but from national and international regulators, as well as the government. And this is what we have done. But before I highlight some of our achievements, I want to ask you a question. One important question for all of you. About climate change. A question to which I would love to hear your answers: Are we — we as supervisors, central bankers, and the financial sector — are we doing enough? Doing enough to manage and prevent climate risks? When we will be looking back, in ten or even only five or three years from now… Will we be convinced that the level of ambition we showed in November 2019 was proportional to the scale and magnitude of the problem, as it was already abundantly known at that time? This is an important question that we need to keep asking ourselves. As we continue on our journey of embedding climate-risks into our practices. Both in the sector, and in our supervision. How climate change impacts insurance companies and pension funds We all remember the scorching heatwaves and droughts of recent years. 18 of the 19 hottest years have all been this century. You all will have seen the images of flooded Venice, where San Marco square is now completely shut off by local authorities, after the second-worst flood ever recorded… Heatwaves, hail storms and floodings have a direct impact on the economy. Reduced productivity… More epidemics and transport disruption… These are just a few of the effects we experienced this summer. Climate-related events and disasters like these present physical risks to the financial sector. And they are of course extremely costly: Insured losses have risen five-fold in the past three decades due to extreme weather. Heatwaves and other natural disasters have a drastic impact on human health. Life and health insurers face mounting claims. Non-life insurers and reinsurers also bear the brunt of claims from property damage caused by storms. The 2018 EIOPA stress test showed that reinsurers are hit particularly hard by losses from natural disasters. Piling extra pressure on this sector. Events in other countries could also lead to higher foreign currency risks. And these effects cascade through the sector. This also brings to mind the issue of the Protection Gap that EIOPA recently studied. Only 35% of losses due to extreme weather and other weather events are insured. That leaves 65% of economic losses uninsured. This begs the question: will these climate risks still be insurable for the sector or even be affordable for consumers in the future? And what can we do about those potential uninsured losses? Are we doing enough to address this issue? And then there is the transition to a sustainable economy. This transition also exposes insurers and pension funds to risks from adapting to new climate policies, rapidly advancing carbon-neutral technology and changing market conditions. But a low carbon economy will ensure sustainable growth and financial stability. A smooth transition is paramount: In 2018 DNB conducted a stress test for a disruptive energy transition. We concluded that it could lead to severe losses for Dutch financial institutions.It is likely that this also applies to financial institutions outside the Netherlands. Steps taken by insurance companies and pension funds Insurers and pension funds did take important steps to integrate sustainability in business models and risk management practices. Good progress has been made in Risk management. Many institutions are embedding climate risk into their risk management. And climate change is also discussed and strategized more often in the boardroom. What’s more, we see institutions conduct scenario analyses. This helps them better understand their risks on the liability and asset-side. This is a big leap in the right direction. However, forward-looking risk management methods still need to be refined. This includes improved scenario analyses: to better understand the effects of climaterelated risks on the institution. We have seen insurers conducting these. Next to this is modeling climate change trends and Nat Cat. I do agree that this comes with a challenge. We cannot predict the future. However, we cannot and must not depend only on historical data to predict the future, certainly when the changes we are seeing are without precedent. Failing to include climate change trends in models, will undoubtedly result in a failure to estimate its impact. Effective risk management should take place, through better informed investment decisions and through considering sensitivity of assets to the energy transition. This includes insurers assessing how best to integrate ESG criteria. Not only in their underwriting practices, but also in their investment decisions. Insurers should also keep customers informed by reporting on sustainability. A DNB study has shown that most Dutch institutions now publish an ESG report. I know that Dutch institutions are not alone in this. Institutions have developed a method to measure the carbon footprint of their investments and loans. They do this through the Platform for Carbon Accounting Financials (PCAF). The Platform helps financial institutions to disclose and align investments with the Paris Agreement. Such methods are vital for investment practices. This is because major institutional investors, insurers and pension funds have potentially large exposures to transition risks. Stemming from the carbonintensive assets on their balance sheets. The investment portfolio of European pension funds and insurers together amounts to over 15 trillion euros. Over 15 trillion euros to be invested… The volume of green bonds and products is rapidly growing. Think about investments in renewable energy. To achieve the EU’s 2030 goals of the Paris Climate agreement, including a 40% cut in greenhouse gas emissions, we need to bridge an investment gap of 180 billion EUR per year. We should be able to achieve this with the collective volume of investments we have in this room today. A higher allocation to green investments could slow the rate of climate change. This also serves to decrease the risk on the liability-side. But, again, we need to keep asking ourselves: Are we doing enough to lower risk? Role of supervisor and regulators We cannot talk about progress without discussing the role of supervisors and regulators. Climate risk transcends borders. The scale of the challenge calls for a national and international supervisory and regulatory approach. At national, European and global level, much work has already been done to embed climate-related risks into our supervisory practices and regulation. Following the European agenda, EIOPA has developed an opinion for the incorporation of sustainability into the Solvency II framework and has also delivered its opinion on the European Commission’s Sustainable Action Plan. One of the EC’s most important projects is the development of a taxonomy. This taxonomy provides a uniform definition of which activities or financial instruments could be considered environmentally sustainable. This will allow us to better see where the risks and opportunities are and gives us a clearer path towards the Paris goals. This will ultimately help insurers and pension funds to determine their investment strategy. De Nederlandsche Bank is also working to take into account climate-related risks in our supervisory framework. Here, we see scope for insurers to take all material risks into account in the Own Risk and Solvency Assessments (ORSA). We have developed and published a good practice document that gives insurers more guidance on how to deal with these risks. For example, as part of their risk management and through scenario analyses. And then there are initiatives on a global level. The establishment of the Network for Greening the Financial System (NGFS) has brought together central banks and supervisors from all over the world, aiming to aid a smooth transition to a low carbon economy and to strengthen the efforts of the financial sector in achieving the Paris goals. The Network will create a document for financial institutions, including asset managers, on good practices for conducting risk analyses. This will be a compilation of methodologies practiced in the market, focused mainly on case studies on Environmental Risk Assessments by financial institutions. The NGFS will also produce a handbook for supervisors on how to assess the climate-related risks of individual firms. We hope this work will be valuable for both the sector and regulators. The Sustainable Insurance Forum (SIF) and the International Association for Insurance Supervisors (IAIS) have joined the NGFS as observers. They are raising awareness and making a valuable contribution to our work. Next year, the IAIS will publish an application paper on climate-related risks. This paper aims putting these risks in the context of the global standards for insurance supervisors. The global standards that are leading for all 200 IAIS members all over the world. There is still more that needs to be done and major milestones to reach, too: supervisors need to continue to build and refine their knowledge on these risks and setting further expectations for the sector. Governments still need to further discuss the protection gap and the issue of a carbon tax…. A carbon tax cannot come quickly enough. The implementation of robust climate policy can prevent further burden and costs for the economy. Beyond climate And speaking about risks, other risks are coming into view… Almost all governments have decided on the Paris agreement - and these decisions may lead to transition risks I spoke of earlier. And other global challenges might also lead to comparable global agreements. And thus to new policies, rules and regulations. And hence new transition risks might occur: from biodiversity loss for instance, from water scarcity, from resource scarcity more in general and from human rights abuses. These are addressed in the UN Sustainable Development Goals. Yet they also bring financial risks with them. Financial risks that must be managed. Financial risks that must be supervised. Just as climate related risks lead to financial risks via the physical and the transition channel, so does - via similar channels – biodiversity loss translate into financial risk. As does water scarcity. And resource scarcity more in general. And human rights abuses. All these financial risks must be managed. And the management of all these financial risks must be supervised. A recent study published by De Nederlandsche Bank found that the majority of Dutch financial institutions have committed to contributing to the SDGs and various sustainability standards and frameworks. The challenges that the SDGs aim to address, if not considered, ultimately will affect the operational environment, the risk management and the business of financial institutions. Above all, these challenges are interlinked. With climate change and rising temperatures comes a decline in biodiversity, in water scarcity, and mass migration. We cannot afford the luxury of ignoring these interlinkages. We cannot afford the luxury of ignoring the multiple and related risks. We cannot focus solely on addressing the risks related to the climatechange during the next decade and only then – somewhere around 2030 - turn our attention to biodiversity-related risks. Or water scarcity. We will need to look at and deal with all these challenges at the same time. Which is now. Supervisors and Central Banks understand that climate change and the transition lead to risks on the one hand and business case opportunities on the other hand. That is why this issue falls within our mandate as supervisors and that is why we are speaking out on this matter. That is why we expect financial institutions to develop sustainable and responsible business practices and to invest responsibly. That means taking SDGs into consideration to ensure responsible decision-making… taking into account all the relevant risks. Do we do enough? We have made relevant progress. And I have mentioned an array of activities we are already undertaking. But there are still many things to work on. Many goals we must still strive towards. Steps have already been taken: I have mentioned the Network for Greening the Financial System (NGFS), Partnership for Carbon Accounting Financial (PCAF), the Commission’s Action Plan on sustainable finance, EIOPA’s opinions published in July, climate stress tests and various national initiatives. We are all aware that there is a need for change. If the climate is changing then so must we. But although we have come very far… Every step of the way, we need to remind ourselves not to ask whether we already have done a lot, but rather we should ask ourselves: are we doing enough? | netherlands bank | 2,019 | 11 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the RiskMinds International seminar - day I: The Risk Regulation Summit, Amsterdam, 2 December 2019. | Risks and benefits of modern financial technology; Lessons from a 17th century stablecoin Speech by Klaas Knot at the RiskMinds International seminar – day I: The Risk Regulation Summit Amsterdam, 2 December 2019 In Amsterdam, on the first day of the RiskMinds International seminar, the theme of the day was ‘The Risk Regulation Summit’. Klaas Knot gave a speech on the risks and benefits of modern financial technology. Whether you are here today as a chief risk officer, regulator, academic or, as in my case, central bank governor, we all seem to be facing the same challenge: how can we find the optimal balance between risk and benefit, in an environment riddled with uncertainty? Today, I want to talk about the risks and benefits of financial technology, or FinTech.1 And what better place to do this than here in Amsterdam? Silicon Valley on the southern shores of San Francisco Bay, the city of Shenzhen in the Chinese Pearl River Delta. They are well-known breeding grounds for the technology of tomorrow. But innovation is common to all ages. And right here in the city of Amsterdam, at the heart of the Amstelland river basin, important innovations occurred as early as in the 17th century. Monetary history is rife with examples of innovations that challenged the status quo. The Bank of Amsterdam did exactly that in the early 17th century. In fact, a forthcoming research paper by the Bank of International Settlements and De Nederlandsche Bank considers the Bank of Amsterdam as an early instance of a stablecoin provider: an issuer of money backed by low-risk assets.2 Today, domestic payments are increasingly convenient, instantaneous and available twenty-four-seven. Cross-border payments, however, remain slow and costly, especially for retail payments such as remittances.3 Recent stablecoin proposals aim to address such inefficiencies in an increasingly digital economy. In a similar manner, the Bank of Amsterdam was founded in 1609 to overcome inefficiencies in payments. In the early 17th century, nearly 850 different gold and silver coins circulated in the economy.4 Debasement, or the deliberate mixing of base metals into these coins, was prevalent.5 This eroded trust in the use of coins as a means of payment. To the detriment of commerce and trade. 1 The Financial Stability Board defines FinTech as technology-enabled innovation in financial services that could result in new business models, applications, processes or products with an associated material effect on the provision of financial services. Notably, this can include innovation by new firms, existing technology firms, and incumbent financial institutions. 2 See Frost J., Shin, H.S. and Wierts, P. (forthcoming), “An Early Stablecoin? The Bank of Amsterdam and the Governance of Money”, BIS working paper. 3 See G7 Working Group on Stablecoins (2019), “Investigating the impact of global stablecoins.” 4 See Van Nieuwkerk, M. van (2007), “Hollands Gouden Glorie, De Financiële Slagkracht van Nederland door de Eeuwen heen.” 5 See Kindleberger, C. and Aliber, R. (2005), ‘Manias, Panics and Crashes: A History of Financial Crises’; Schnabel, I. and Shin, H.S. (2018), “Money and Trust: Lessons from the 1620s for Money in the Digital Age”, BIS Working Paper No. 698. To restore confidence, the Bank of Amsterdam started issuing money in the form of bank deposits – the bank guilder. On the liability side of the balance sheet, the bank held current account deposits, with balances rising from 4.9 million guilders in 1673 to 28.9 million in 1721. On the asset side, the bank’s charter required that deposits were fully backed by precious metals. This boosted confidence, much like current stablecoin proposals aim to achieve price stability by being pegged to a basket of fiat currencies. In his seminal work, The Wealth of Nations, Adam Smith noted: At Amsterdam, no point of faith is better established than that for every guilder, circulated as bank money, there is a correspondent guilder in gold or silver to be found in the treasure of the bank. The city is guarantee that it should be so. The Bank of Amsterdam supported payments and settlements across Europe for nearly two centuries. It relied on an ‘ecosystem’ of cashiers, provided standard contracts and managed operational risks, such as a fire in 1652 – cyber-attacks had yet to be invented. Similar to modern wholesale payment systems, the bank was able to bridge differences between outgoing and incoming payments. But in doing so, the bank’s management also departed from the strict application of its charter, performing some of the liquidity provision functions that a modern central bank provides. Its success may also have been the bank’s undoing. In the late 1770s, the bank started granting larger and larger overdrafts to the Dutch East India Company, while never disclosing them. Over time, the bank had accumulated large credit exposures which soon became non-performing. The full extent of lending exposures remained hidden from public view for a further decade. However, the demise of the Amsterdam Bank came through a run on its gold and silver in 1795, following the invasion of the French Revolutionary Army. What lessons can we draw from this chapter in monetary history? For one, financial innovation is common to all ages. So, too, are financial risks. Adequate risk management, sound governance, financial regulation, supervision, deposit insurance, crisis management – they are all necessary to safeguard confidence in the financial system. Second, this episode points to a fundamental dilemma that lies behind privately issued stablecoins. Having a full backing requirement creates trust, but also implies limited settlement liquidity.6 Credit is needed to ‘oil the wheels’, especially in wholesale payments. For the Netherlands, payment values are in excess of 100 times GDP. Issuers of stablecoins may therefore have an incentive to start lending. But doing so is at odds with their stated objective. Which is to stabilise the value of the coin through full backing. And lending exposes the issuer to credit risk and to potential runs when confidence falls away. Not to mention a whole range of relevant issues around legal certainty, financial integrity and data protection identified by the G7 and the Financial Stability Board. Careful consideration of regulatory and supervisory implications is therefore needed before any global stablecoin-type initiative can be launched successfully.7 With these lessons in mind, let’s have a closer look at the risks and benefits of modern financial technology. The past few years have seen the growing application of technology-driven innovation in financial services. This is the result of a combination of drivers.8 Evolving technology related to big data, artificial intelligence, distributed ledgers and computing power has increased the rate of FinTech adoption exponentially. Customer preferences regarding convenience, speed and costs are becoming increasingly important. Especially among the younger demographic of digital natives. Business opportunities have emerged in areas that traditional financial institutions may have overlooked. Opening up the way for new entrants. And there is no doubt that FinTech brings significant potential for societal good and welfare, especially in the developing world.9 Around the world, 1.7 billon adults are unbanked or underserved with respect to financial services.10 In many countries, FinTech is already helping the unbanked and small businesses to access finance. From rural households in China, who can invest in a money market fund on their smartphone, to retailers in India, who can accept new forms of payments from their customers. In advanced economies, as well, consumers stand to benefit. New market entrants can offer innovative services efficiently thanks to fully digital business models and 6 See Frost J., Shin, H.S. and Wierts, P. (forthcoming). 7 See Financial Stability Board (2019), “Regulatory Issues of Stablecoins”; G7 Working Group on Stablecoins (2019). 8 See Financial Stability Board (2017), “Financial Stability Implications from FinTech, Supervisory and Regulatory Issues that Merit Authorities’ Attention.” 9 See Bank for International Settlements (2019), “Welfare implications of digital financial innovation.” 10 World Bank (2019). the use of latest technologies. They also stimulate incumbent entities to invest in modernising their services.11 Regulatory reforms are also contributing to this. In Europe, PSD2 enables third-parties to access payment-related data previously only available to banks. Consumer consent is of course required. In the Netherlands, new and innovative services are starting to emerge in areas such as payments and personal finance management. These are offered by new entrants, banks, or through partnerships. Of course, customers have to trust these new services. The combination of payment data with large volumes of personal data in particular could lead to privacy concerns among the general public. A recent survey carried out by De Nederlandsche Bank shows that, on average, 11 percent of respondents are willing to give consent to various forms of data usage. Nearly 72 percent are not prepared to do so. And more than 59 percent of the respondents would be more inclined to allow a bank more active use of payment data than they would a tech company.12 This makes public trust an asset of great value for the banking sector at this juncture. But it remains to be seen how these developments will impact the banking sector in the longer run.13 Let’s look at the risk side of the equation. Despite their innovative character, FinTech activities remain subject to traditional risks.14 Activities that resemble deposit taking remain subject to liquidity mismatches and the potential for runs. New financial assets can still be subject to speculative bubbles. Early crypto-assets such as Bitcoin have exhibited extreme price-volatility, for example. If specific firms achieve a large enough scale, there is still potential for them to become systemically important. The data-driven business models of some large technology firms in particular can generate strong and selfreinforcing network effects.15 New forms of interconnectedness could still transmit shocks across institutions and markets. Outsourcing, for example, increases the complexity of value chains and could give rise to new forms of concentration risks, as third parties take on roles that may be of systemic importance. And advanced 11 See De Nederlandsche Bank (2018), “Supervision in an open banking sector.” See De Nederlandsche Bank (2019), “Dutch consumers reluctant to share bank data”, DNBulletin. 13 See Basel Committee on Banking Supervision (2019), “Implications of FinTech Developments for Banks and Bank Supervisors.” 14 See Financial Stability Board (2019), “FinTech and Market Structure in Financial Services: Market Developments and Potential Financial Stability Implications.” 15 See Bank for International Settlements (2019), “Chapter III, Big tech in Finance: Opportunities and Risks”, in BIS Annual Economic Report, 2018. cyber-attacks on financial institutions and market infrastructures could destabilise the financial system.16 So what does the risk-benefit balance of FinTech look like today? At least for now, technology by itself does not seem to pose a material risk to financial stability. Compared with an incumbent financial system with assets of 382 trillion USD globally, FinTech activity is still modest. The total amount of new credit provided by FinTech and BigTech companies is relatively small. At the end of 2017 it stood at 0.5 percent of total credit.17 New FinTech business models rarely entail significant risk transformation.18And while the introduction of global stablecoins could pose a host of challenges, crypto-assets do not pose a threat to financial stability at this point, given their limited market capitalisation.19 Nevertheless, there are developments that warrant close attention going forward. I have already mentioned growing operational risks of outsourcing and cyber security that may have financial stability repercussions. Furthermore, the entry of BigTech firms – large companies with established technology platforms – into financial services could drastically increase the scale and pace of innovation. BigTechs firms have the ability to scale up rapidly by leveraging several comparative advantages. These include their large established and global customer base, brand recognition, proprietary customer data and stateof-the-art technology. In some emerging markets and developing economies, BigTechs have managed to reach large – and previously unbanked – sections of the population. For instance, BigTech mobile payments make up 16 percent of GDP in China.20 From there, they have gradually expanded their foothold with range of services, such as lending, insurance and asset management. In advanced economies, BigTech financial activities are generally narrower. This may be due to differences in financial development and existing market structures, such as a large banked population and pre-existing payment infrastructures. 16 See De Nederlandsche Bank (2019), “Financial Stability Report – Spring 2019.” 17 See Frost, J. (forthcoming), “The Economic Forces Driving FinTech Adoption across Countries, in King, M. and Nesbitt, R. (eds.), The Technological Revolution in Banking, Toronto University Press. 18 See Restoy (2019), “Regulating FinTech: what is going on, and where are the challenges?” 19 See Financial Stability Board (2019), “Chair’s letter to G20 Finance Ministers and Central Bank Governors”, 13 October 2019. 20 See Bank for International Settlements (2019). Nevertheless, BigTechs are becoming increasingly active in the European payments markets.21 In the Netherlands, BigTech firms are now active in payments – although still through partnerships with banks. And BigTechs do not only serve retail customers, but also provide cloud services to financial institutions. Taken together, the entry of BigTechs at both ends of the financial services value chain may pose risks to financial stability that are more prominent than those from FinTech firms. The increase in the scale and pace of innovation also demands innovation from regulators and supervisors. Most of all, it calls on us to broaden our perspectives. Supervisors need to coordinate their actions with those taken in other policy domains. Particularly, data protection and competition. In addition to this horizontal expansion of innovative cooperation, we also need to step up international, or vertical cooperation. This stems from the global scope of FinTech and the international business models of especially BigTechs. Recent discussion on global stablecoin arrangements such as Libra illustrate this point. Going forward, the Financial Stability Board and the international standard setting bodies have a crucial role to play here. Let’s jump back to 1609 for a final hypothetical thought: would the Bank of Amsterdam have survived if the full package of CRD, CRR, BRRD, AMLD, SSM and SRM had been in place? It is likely that the bank would have been in a better place. But can we be certain? No. Today there are still banks with shortcomings in their risk management, weak governance, stocks of non-performing loans – the same issues the Bank of Amsterdam was facing. That is why risk managers like you have a crucial role to play. To cover all possible angles and find the optimal balance between risks and benefits. At least one thing is for sure: had De Nederlandsche Bank more smartly presented itself as the Bank of Amsterdam’s successor in 1814, then, not the Swedish Riksbank, but DNB could lay claim to being the world’s oldest central bank. But this is an issue I will probably have to take up with Stefan Ingves, who, apart from being well-known in our banking regulatory circles, can also lay claim to be the governor of the oldest central bank in the world. 21 De Nederlandsche Bank (2019), BigTech Companies Increasingly Active in European Payment Markets”, DNBulletin. So let me conclude. Whether we are dealing with deposits of bullion in the seventeenth century, or the rise of stablecoins in the twenty-first century, all forms of financial innovation pose risks and benefits. And while we can learn valuable lessons from history about where financial innovation went wrong, there is no guarantee that the approaches and mechanisms we put in place in the past can adequately address all conceivable risks in the future. So in a rapidly shifting landscape of risks and benefits, we need to refocus on where the risks lie, while not losing sight of the risks we have always faced. Expanding and strengthening cooperation is needed so we are not blindsided by these risks, and do not miss out on the benefits. Thank you. | netherlands bank | 2,019 | 12 |
Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, at the 82nd Plenary Meeting of the Group of Thirty, Federal Reserve Bank of New York, New York, City, 6 December 2019. | Macroprudential modesty Introductory remarks by Klaas Knot, at the 82nd Plenary Meeting of the Group of Thirty Federal Reserve Bank of New York, 6 December 2019 At the G30 meeting, hosted by the Federal Reserve Bank of New York, a panel session was held on ‘The Future of Macroeconomic Policies’. Klaas Knot was one of the panelists. In his opening statement he discussed the role of macroprudential policies in addressing financial vulnerabilities. He stressed the need to be realistic in our expectations on what macroprudential policies can deliver under the current circumstances. The macroprudential toolkit, Mr. Knot said, is limited in scope and impact to mitigate systemic risks. He stressed that financial stability has to be a relevant factor to take into account in the overall macroeconomic policy mix. Introduction What a difference a year can make. In December 2018, the ECB decided to end its net purchases under the Asset Purchase Program and it was believed that 2019 would focus on steps towards monetary policy normalization. Now, one year later, rates have been cut both in the US and in Europe and net asset purchases have restarted in Europe. The main theme in international discussions at the FSB and IMF is the prolonged nature of low interest rates. These discussions focus on the structural level of the natural interest rate and are reflected in terms as ‘low-for-long’ or even ‘low forever’. The weakening of the economic outlook and shift in financial conditions have increased stability risks in the global financial system. I will argue today that we need to be realistic in our expectations on what macroprudential policies can deliver under the current circumstances to safeguard financial stability. The macroprudential toolkit is limited in scope and impact to mitigate systemic risks. Following this observation, it also raises important (and sometimes new) questions on the implications for the overall macroeconomic policy mix. I. Vulnerabilities in the financial system In order to discuss the role of macroprudential policies in current economic circumstances, let’s first take a look at the main pockets of vulnerabilities featuring prominently in the FSB’s semi-annual exercises. As my goal is to map macroprudential policies onto these vulnerabilities, I will abstain from geopolitical risks such as trade disputes and Brexit. Credit growth / leverage First of all, the low-interest rate environment leads to a search for yield, which can lead to a situation where returns no longer reflect underlying risk fundamentals. For example, at the FSB, we are closely monitoring developments in leveraged finance and the CLO market. This market has grown to an estimated total of 3.2 trillion USD and has been accompanied by declining lending standards and higher corporate leverage. Covenant-lite loans were rare prior to the crisis, but since 2009 its share of issuance has increased to 50-80%. Moreover, there has been an increase in leverage and deterioration in credit quality. Over 60% of outstanding loans has a single B credit rating or lower. Needless to say, such lending activities are vulnerable to a sudden change in market sentiment, a rise in interest rates or deterioration of the economic situation. Public and private indebtedness A second important effect is that the low interest rate environment has led to a strong increase in total debt, both within the public as well as the private sector. Total debt-to-GDP ratios stand at 350% for Japan, and around 250% for the US, the UK and the Euro Area. Higher debt levels may reflect a response to structurally lower interest rates and therefore structurally higher sustainable debt levels, but they can also create vulnerabilities. For example, despite the favorable economic conditions in recent years, very few countries have actually reduced their public debt ratio. In the current environment, governments do not face financing constraints. Debt sustainability issues could however resurface when market sentiment shifts and risk premia were to increase. Sovereign debts are particularly prominent in Europe, where the preferential treatment of sovereign exposures effectively implies zero-risk-weighting at the banks. Corporate indebtedness in advanced economies has also been rising and has peaked over 160% of GDP. This might result in a debt trap where corporates can only service their debt because of the low interest rates, but do not have sufficient underlying earning capacity to cope with an unexpected rise in interest rates (zombification). Real estate markets The third systemic risk that I want to mention is the strong increase in both residential housing prices and commercial real estate in recent years. Real estate markets have traditionally been an important factor in the development or amplification of financial crises. Several jurisdictions show increased signals of overvaluation in significant segments of the market. II. Macroprudential toolkit Given the current stance of monetary policy and the outlook of a prolonged period of low interest rates, it is logical to first look to what extent macroprudential policies would be able to mitigate these systemic risks. The figure below provides for a mapping of our current macroprudential toolbox, based on EU/Dutch legislation. The green boxes indicate the instruments that most central banks have at their disposal. The salmon colored boxes are measures that can be applied by macroprudential authorities, but whose effectiveness in mitigating systemic risks is generally perceived to be limited. The red boxes indicate instruments that could be applied, but are currently not within the remit of most central banks. Finally, there are several white boxes which indicate that no specific macroprudential instrument is available. Figure 1: Curent macroprudential toolbox based on EU/Dutch legislation Source: based on brochure DNB's financial stability task So what do we conclude from this overview? Allow me to make three observations. First, the macroprudential framework does not provide a fully-covered system. Contrary to monetary policy that ‘gets into all the cracks’, macroprudential policies are limited to specific parts of the financial system. Available measures are also almost exclusively targeted towards banks, which implies a potential for risk-shifting beyond the banking sector. Second, macroprudential measures are mostly targeted at strengthening resilience, but not at addressing the build-up of underlying vulnerabilities. Current available instruments create buffers to better absorb losses when they occur, but they neither improve the functioning of the real economy, nor do they stem the origination of losses. For example, an important systemic risk like corporate indebtedness cannot be directly addressed by macroprudential authorities. Thirdly, potentially very effective measures often do not fall within the remit of macroprudential authorities. Such measures are often considered too important from an electoral perspective to delegate their activation to independent authorities. These include sovereign risk weights, borrowerbased limits and preferential tax incentives. They are often part of broader economic trade-offs, thereby however creating a reality that macroprudential authorities cannot employ full ammunition to address systemic risks. III. Policy implications So my main message today is that of macroprudential modesty. Although important frameworks have been developed in the aftermath of the global financial crisis, we cannot regard them to be at par with monetary or fiscal policies. The impact of macroprudential measures are unlikely to be as forceful as monetary policy, as they at their very best slow down the build-up of stability risks within the financial system. This has several important policy implications. For one, despite of the limitations I sketched, we should remain committed to full implementation of the international reform agenda. Limitations in scope and impact cannot be an argument to deregulate. But on top of this, we should continue to work on structural challenges within the economy and its financial system. Importantly, we should also continue to think about the implications for the overall macroeconomic policy mix. The observation that macroprudential policies cannot be fully relied upon to contain systemic risks would also have to be taken into account in the conduct of monetary and fiscal policy. To be clear: it should not have an impact on the mandate or direction of monetary policy, which would continue to be fully geared towards price stability. However, financial stability would have to be a relevant factor to take into account within the design and the proportionality of policy measures. Obviously, these are complex observations that require further analysis. I look forward to discuss these and related matters in our quest for further operationalization of effective macroprudential policies. | netherlands bank | 2,019 | 12 |
Opening statement by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, at the Conference "Climate Change. Challenges for the Financial System", organized by the Bank of Spain, Madrid, 11 December 2019. | “Climate crisis requires urgent action by financial sector and financial supervisors” Opening statement Frank Elderson at the Banco de España Climate Change Conference Madrid, 11 December 2019 At the Climate Conference the Banco de España hosted in Madrid, a panel session was held with as main topic: the challenges for the Financial System posed by climate change. Frank Elderson was invited for this panel and opened the session by stating that the current climate crisis requires urgent action by governments, financial sector and supervisors. Fifteen of the twenty largest fires in California history have occurred since 2000, since the 1970s, there has been a fivefold increase in the annual burned area in the state. Half of all coral reef systems in the world have been destroyed, putting a quarter of marine life at risk. In Australia, rainfall for January to August 2019 was the lowest on record in Queensland and New South Wales. Tenterfield and Stanthorpe were 77% below the long-term average. Droughts in Southern Africa are causing taps to run dry, and a record 45 million people facing severe food shortages. Victoria Falls in Zambia is experiencing unprecedented droughts and is at risk of drying up because of climate change, warns Zambian president. Average water flow at the popular tourist attraction is down by half in 2019. The recent flooding in Venice left 70% of the historic centre under water. Luigi Brugnaro, mayor of Venice, has estimated the damage will be over €1 billion. Extreme weather events in East African countries like South Sudan, Kenya and Somalia have led to floods that have affected more than three million people, pushing hundreds of thousands from their homes and resulted in more than 250 deaths. And this this is only a short overview of recent media reports. Serious tipping points seem to be reached shortly. As recently published by Science Advances, more than one third of Earth’s 435,000 plant species, are exceedingly rare. Unprecedented sea ice loss in the Arctic, both in ice volume and in thickness. Only if global emissions fall by more than 7 percent each year, between 2020 and 2030, can the Paris climate target of 1.5 degrees of global warming be achieved. But so far, emissions have been rising every year, once again to a record high in 2018. And there are serious financial consequences. In 2018 the world suffered $166 billion in losses from extreme events related to climate change. Earlier this year, Lloyd's of London announced a $1.3 billion loss, due to an increase in extreme-weather related insurance claims. We have seen the first - and probably not last - Climate-Change Bankruptcy with the fast fall of PG&E after California’s wildfires. A 2018 report from the Intergovernmental Panel on Climate Change estimated that global economic damages by 2100 would reach $54 trillion with a 1.5-degrees Celsius of warming of the planet, $69 trillion with 2 degrees Celsius of warming and $551 trillion with 3.7 degrees Celsius of warming.1 Due to the droughts in Zambia, the water and power shortages are set to shrink the country’s economy by 6.5 per cent this year. And there is an increase in climate litigation. As of May 2018, more than 1000 cases had been filed in 25 jurisdictions.2 In the already famous Peruvian farmer case, Lliuya argues that RWE, as one of the world’s top emitters of climate-altering carbon dioxide, must share in the cost of protecting his hometown Huaraz from a swollen glacier lake at risk of overflowing from melting snow and ice. Mark Carney, governor of the Bank of England, has recently warned that the global financial system is backing carbon-producing projects that will raise the temperature of the planet by over 4°C. More than double the pledge to limit increases to well below 20C contained in the Paris Agreement. While the world is experiencing the severe impact of climate change already on a daily basis, we are far from where we should be and on our way to making it worse. This is why from now on I will no longer use the too neutral, too comfortable phrase ‘climate change’. Just like the ECB president, Christine Lagarde, stated during a hearing at the European Parliament Economic Affairs Committee: we are in the middle of a “climate emergency”. From now on I will call it what it is: a crisis. The Climate Crisis. Now this is not the end of the story. Crises need to be fought. All over the world steps are being taken to fight this climate crisis. And it is being fought on many fronts. Let me now focus on the financial front. I am very pleased that last week, EU negotiators have agreed a deal to establish a taxonomy, a common set of European rules on what can be considered a green investment. This taxonomy is not only essential for the financial sector. It will help all economic actors to identify which economic activities contribute to the transition to a green and low-carbon economy. https://www.ipcc.ch/sr15/ M. Nachmany & J. Setzer, ‘Global Trends in Climate Change Legislation and Litigation: 2018Ssnapshot’, Grantham Research Institute report, May 2018, p. 5. The work of the European Committee on disclosure requirements is also something we encourage as a financial supervisor. It contributes to more insight into - and transparency about - climate-related risks and exposures of financial companies under supervision. The network of central banks and regulators for greening the financial system, the NGFS -of which by the way our hosts, the Banco de España where among the first members - the Network is growing and growing. It is now almost easier to name the central banks who haven’t yet joined, than to give you a full list of all central banks and regulators who share our concerns. I stand here also in my capacity as chair of this network. The network that in its first publication stated that climate change is a driver of financial risk. The network that stated: taking the consequences of climate change seriously, falls squarely within our mandates as central banks and supervisors. The network that called for action by setting six recommendations to manage risks and scale up green finance. These six recommendations were published in an NGFS report earlier this year, and are already seeing follow-up. Next year, we expect to come up with at least three new publications, with which we facilitate the financial sector to assist in reaching the objectives of the Paris Agreement. One about transition scenarios and guidelines for scenario-based climate risk analysis. And a publication on current environmental risk assessments methodologies. And a guide on integrating climate & environmental risk into supervision. And while exchanging experiences and ideas, the fifty-four NGFS members are also looking closer into risk differentials between green and brown assets, and the market dynamics around green finance. The climate crisis needs to be fought on many fronts. Many actors have a vital role to play. Governments, private firms, NGOs, scientists, consumers, the press... And of course, also the financial sector has a vital role to play: banks, insurance companies, pension funds, investment funds, credit rating agencies. And, and this is why I stand here: also central banks and supervisors have a vital role to play. The good news is, that a growing number of us realises this, and acts upon it. All 54 members of the NGFS. A number that continues to grow fast. There is strong resolve to act, within the Bundesanstalt für Finanzdienstleistungsaufsicht, the Banque de France, the Bank of England, the Bank Al-Maghrib, el Banco de Mexico, the New York State Department of Financial Services, the People’s Bank of China, the Mionetary Authority of Singapore, De Nederlandsche Bank. And of course within el Bance de España. And so I could go on 54 times. And growing. And the sector is stepping up. The Dutch financial sector, our banks, pension funds, insurers and asset managers, have pledged to actively contribute to the implementation of the Paris Agreement. Just like the Spanish sector has very recently done, as I read in El Pais this week. The Dutch financial sector’s commitment to making the energy transition a success involves the commitment to measure and publicly report the carbon footprint of their relevant financing and investment activities from 2020 onwards and reduction targets for 2030, for all their relevant financing and investment activities by no later than 2022. Also parties who some might not immediately think of to be at the forefront of fighting the climate crisis are taking concrete actions. This week, hedge fund TCI, which manages assets worth $28bn, has written to companies including Airbus, Moody’s and Google parent Alphabet warning them to improve their emissions disclosures or they will vote against their directors. TCI called upon asset owners to fire asset managers that do not require such disclosure. So now the only logical step for me, is to call upon you. Everyone here present today, to act. We are very much in need for internationally concerted efforts to address the climate crisis. Ever more central banks and financial supervisors realise also they have a role to play. Not because they engage in politics, but because their mandate requires them to. And in increasing numbers, they act. No one can look away. No climatologist. No politician. No banker. No investor. But also no central banker. And no supervisor. We must act. We must act now with an urgency commensurate with the speed the climate crisis is unfolding. We must step up our game. There is no place to hide. There is no plan B because there is no planet B. And as long as sea levels continue to rise, we as central banks, acting squarely within our mandate, will continue to raise the bar. | netherlands bank | 2,019 | 12 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the farewell seminar for ABN Amro's Chief Economist Han de Jong, Amsterdam, 4 December 2019. | What do low inflation and low interest rates mean for monetary policy? Amsterdam, 4 December 2019 At the farewell seminar for ABN Amro’s chief economist Han de Jong, Klaas Knot was one of the speakers. In his speech, Klaas Knot outlined the main challenges that constitute a point of departure for the review of the ECB’s strategy that is anticipated to start formally in the new year. It is a pleasure to say a few words in honor of Han De Jong. Han has written a great deal about macroeconomic policy issues. The topics range from the peculiarities of the Dutch pension system and housing market. To worldwide economic trends and the impact of statements of politicians like Johnson and Trump. I would like to thank Han for his valuable and thought-provoking views over the years. As Han has been the chief economist of ABN AMRO for 14 years, he has covered a considerable part of the lifespan of the euro. Here I have to inform you that Han and I share a special interest in the magic number 14. Not because my own term is maximized by law to 14 years in total. But because of our predilection for the legendary number 14: Johan Cruijff of Amsterdam’s football club Ajax. The football team where Han and I both attend the occasional home matches. Apart from his impact on the game, Han and I know that Cruijff’s legacy also carries lessons for chief economists and central bank governors. Han for instance already covered the link between football and economics in 2000, when he, provokingly for a Dutch economist, stated that a German victory during the European Championship would be best for the euro area economy. As Cruijff did in his days, economists have an inclination to speak in a language that can leave an audience confused at a higher level. Or, as Johan Cruijff once proclaimed: “If I wanted you to understand, I would have explained it better.” Well, Han’s work shows the importance of explaining better, to improve all of our understanding of the economic challenges that policymakers face. I very much hope that you will find my contribution reflects this philosophy. For this afternoon, I was asked to talk about the implications for monetary policy of persistently low inflation. When preparing this speech, I remembered some advice Han gave on monetary policy some five years ago: “The ECB should not follow the example of the Fed and embark on QE”. I wonder how Han reflects on this quote today, looking at the current calibration of monetary policy on both sides of the Atlantic. Whereas by now the Fed has unwound the bulk of its QE-portfolio, the ECB restarted net purchases under its QE-program as recently as in September. But today, I will not dwell on the merits of the policy package that was adopted in September and has been discussed extensively afterwards. Instead, I will focus on longer-term challenges for monetary policy. In my view, these challenges constitute a point of departure for the review of the ECB’s strategy that is anticipated to start formally in the new year. Earlier this week, Han remarked in the Dutch newspaper Het Financieele Dagblad that a new captain is in charge of developing a new strategy for his team.1 Well, this is also the case for the ECB. I will focus on three challenges affecting central banks worldwide. I will also discuss two challenges related to the specific context in which the ECB operates. I will argue that these challenges warrant a discussion in the upcoming review of the monetary policy strategy on the merits of increased flexibility with respect to our inflation aim. Three challenges for central banks worldwide Let me start by outlining three challenges that are not unique to the ECB, but apply more broadly to central banks worldwide. The first challenge, of course, is the fact that in the current environment, inflation is persistently low, and no one knows exactly why… Different possible explanations for this phenomenon have been put forward, of which I would like to mention four: 1. We now see a weaker relationship between real economic activity and inflation than in the past. 2. Inflation may be subject to more negative shocks than in the past. 3. Inflation expectations are increasingly backward-looking. 4. And, finally, inflation may be subject to a declining trend in some of its underlying components. This explanation has been confirmed by recent DNB research.2 To be more precise, I am not talking here about a secular declining trend that will inherently go on forever. Some of the underlying drivers of this trend, like globalization or ageing, might fade away or reverse, as was also stipulated by Carl Tannenbaum. The process of globalization of the past decades for example might reverse due to an ongoing escalation in protectionism. The various explanations for persistently low inflation are interrelated and may to some extent co-exist. In terms of their implications, they share two important lessons: 1. The uncertainty surrounding the drivers of inflation has increased over the years. 2. Inflation is subject to incomplete control by central bankers.3 https://fd.nl/economie‐politiek/1326407/economen‐zijn‐niet‐de‐meest‐moedige‐mensen See Hindrayanto, I., Samarina, A. and I. Stanga (2019). Is the Phillips curve still alive? Evidence from the euro area. Economics Letters 174, 149‐152. 3 See also “The quest for policy scope: Implications for monetary policy strategies”, speech at The fourth annual high‐level conference Racing for Economic Leadership: EU‐US Perspectives, New York, 16 October 2019. The second challenge relates to the reduced room for maneuver central bankers have. When trying to address persistently low inflation, at some point monetary policy will hit the effective lower bound on short-term interest rates. Beyond that point, increasing side-effects start to outweigh the marginal returns of taking the policy rate deeper into negative territory. This lower bound is more relevant today than it was in the past. Interest rates, for a variety of reasons mostly outside the realm of monetary policy, have declined substantially since the 1980s.4 This implies that central banks have less conventional policy space when confronted with a recession. In order to provide additional accommodation with policy rates at the effective lower bound, central banks have developed and employed unconventional monetary policy instruments. And with unconventional monetary policy instruments comes the third challenge. Despite the experiences gained in recent years, our understanding of unconventional tools like forward guidance, asset purchases and long-term credit operations is still less developed than our understanding of conventional tools. Hence, the impact of these instruments remains subject to considerably more uncertainty than that of conventional instruments. Moreover, the effect of unconventional instruments on financial conditions, and ultimately inflation, depends very much on the specific conditions under which they are implemented. And, therefore, can also differ over time. More specifically, the impact of balance sheet instruments crucially depends on the existence of financial frictions. Because these frictions are what shape the impact of such central bank interventions on financial conditions. A central bank can for instance effectively suppress risk premia by increasing its role as an intermediary.5 There is, however, an important catch: relevant frictions may not only reflect temporary market disfunctioning, they could also reflect more structural underlying problems that monetary policy measures cannot resolve. If the central bank were to respond to the latter, it would intervene in areas where other players have a responsibility to act. The key challenge is therefore to assess which circumstances apply, before deciding on the most appropriate instrument or set of instruments to activate. For a discussion of these results in a broader context, see Bonam, D., Galati, G., Hindrayanto, I., Hoeberichts, M., Samarina, A. and I. Stanga (2019). Inflation in the euro area since the Global Financial Crisis. DNB Occasional Study No.3. 5 See for instance Gertler and Karadi (2015), Monetary policy surprises, credit costs, and economic activity, American Economic Journal, 7(1), 44‐76. It is important to note that, next to the higher level of uncertainty, employing unconventional tools will also likely carry larger risks, for instance in terms of longer-run side–effects. I have therefore argued before that policymakers should consider exercising more caution in deploying unconventional instruments.6 In times of severe market stress with equally severe frictions, however, the advantages of more aggressive action might outweigh the disadvantages of higher uncertainty and larger risks. Specific challenges for the ECB Against this backdrop, let me focus on two additional challenges related to the institutional context within which the ECB operates. The first challenge here is provided by the observation that the ECB has to operate in an incomplete monetary union with a more convoluted process of policy coordination. The design of our Economic and Monetary Union remains a compromise between limited risk-sharing and a large degree of national liability and control. This confronts the ECB with more institutional restrictions than other central banks. It has to deal with 19 different fiscal counterparts, for instance, all of which face different sovereign risk premia. This makes the purchase of government bonds more fraught than in other jurisdictions. To what extent further steps toward fiscal risk-sharing should be taken, is very much a political question. From my perspective, I can only note that more effective fiscal stabilization would have the potential to make the ECB’s job significantly easier. The second challenge specifically faced by the ECB relates to the euro area’s financial architecture. Within the euro area, banks play a dominant role. Pervasive banking sector weaknesses like non-performing loans and the bank-sovereign nexus, have plagued the euro area for a long time. Given the importance of banks for credit provision to the real economy, the ECB employed a wide variety of unconventional instruments to address impairments in monetary transmission. At the same time, deposit insurance schemes and macro-prudential policies are still a national responsibility and the banking sector remains fragmented along national lines. Financial frictions may therefore also emerge along national lines. This creates additional uncertainties and interdependencies for the ECB. Before I conclude, let me say some more words about the design of EMU in light of these ECB-specific challenges I just mentioned. In the aftermath of the crisis, EMU’s functioning has been enhanced, for instance, by the establishment of the European “Knows and unknowns of monetary policy instruments: implications for monetary policy strategies”, speech at the European Banking Institute’s policy conference, Frankfurt, 14 November 2019. Stability Mechanism and the steps towards a European Banking Union. Such enhancements help align the incentives for policy action by other players with those of us, monetary policymakers. This is helpful for monetary policy in two ways. First, it reduces the likelihood of adverse shocks hitting the economy to which monetary policy would need to respond. And where monetary policy would need to respond to risks to price stability, the risk of undesirable side-effects is reduced. There is however no room for complacency. Future steps to complete the EMU could provide further comfort to the ECB that monetary policy will not be the only game in town. Fostering more risk-sharing, would for instance entail developing a Capital Markets Union and completing the Banking Union by means of a European Deposit Insurance Scheme. This, by the way, was already foreseen by Han de Jong as early as in 1980, when he joined the European Commission to work on proposals for harmonizing deposit insurance schemes in Europe! Conclusion So let me conclude. Today I discussed what I see as the main challenges for central banks worldwide and the ECB in particular. These challenges underline the need for a review of the monetary policy strategy under the new ECB-presidency. And, as I have also tried to illustrate, some of these challenges imply that elements and lessons from other central banks cannot always be transposed onto the ECB. A discussion is therefore warranted on the merits of increased flexibility. The ECB has to navigate its policy in a world characterised by: 1. Elevated uncertainties surrounding the inflation process. 2. Inherent uncertainties surrounding the employment of unconventional instruments at the effective lower bound. 3. Pervasive uncertainties as to the degree of alignment with other policymaker’s actions and its impact on financial fragmentation. Some of the challenges, like those created by the effective lower bound, are only relevant when inflation is below our aim. But flexibility could, in principle, be applied in either direction: both when inflation is below or above our aim. One way to increase the flexibility of our monetary policy strategy would be to introduce a symmetric band around the inflation aim. Another way would be to lengthen the time horizon over which inflation should return toward its aim. Both approaches would buy us time and flexibility in responding to forces we simply cannot control. In doing so, it would help us communicate our commitment to price stability in a more appropriate fashion, by being humble about our limited control over short-run inflation and about the inherent uncertainties surrounding unconventional instrument applicability. Let me then conclude with one more quote by our shared hero Johan Cruijff: “You’ll only see it, once you get it.” Han, thanks for helping us at least to see it, over these last 14 years. | netherlands bank | 2,019 | 12 |
Opening remarks by Mr Klaas Knot, President of the Netherlands Bank, at the SUERF/Netherlands Bank Conference "Forging a new future between the UK and the EU", Amsterdam, 8 January 2020. | “Interests and alliances” Opening remarks by Klaas Knot at the SUERF conference ‘Forging a new future between the UK and the EU’ Amsterdam, 8 January 2020 The SUERF Conference of January 2020 brought together thought leaders from policy making, academia and industry, to discuss the economic implications of some of the challenges uncovered by Brexit and other recent events on both sides of the Channel. Because the conference was held at De Nederlandsche Bank in Amsterdam, Klaas Knot was invited for an opening keynote speech. In it, Mr Knot offered an optimistic view on the future relationship between the UK and the EU, based on the shared interests and the current and possible future alliances. It is my pleasure to welcome you all here at the Dutch Central Bank. And a special welcome to our distinguished speakers and panelists. A new year, a new decade, and a good moment to discuss the future relationship between the EU and the UK. Indeed, political developments over the coming months will be vital in shaping this new relationship. Henry Kissinger – the former US Secretary of State, famously said that “America has no permanent friends or enemies, only interests. This echoes what Lord Palmerston – the 19th century UK prime minister – once said: “the UK does not have eternal allies, nor perpetual enemies, but eternal and perpetual interests.” Let me now fast forward to today’s world of Brexit. Obviously, a politician or political party can persuade people to vote to leave the European Union. A member state can decide to abandon a treaty, or to withdraw from an agreement. Every nation has its own - sometimes narrow - political interests. These interests clearly matter over the course of history, and they probably will continue to do so for a long time to come. When Kissinger and Palmerston contemplated the alliances and interests of nations, they of course considered that the interests of nations can diverge. And alliances could therefore be temporary. But let us now take a different perspective. A perspective that also rings true. And which offers us a more optimistic view. First, nations do not just have divergent or competing interests, but also enduring common interests. Indeed, the EU and the UK continue to face very similar challenges and opportunities. Some of which will be discussed today and to which I will return shortly. Second, alliances may indeed be temporary, such as the UK’s membership of the European Union. But at the same time, other alliances between the EU and the UK will endure. One example is our common determination to green the financial system by means of the Network for Greening the Financial System. Also, new alliances may emerge, such as a future trade relationship between the EU and the UK. I would now like to further elaborate on the EU’s and UK’s shared interests and future alliances. And I will do so along the lines of the three main topics that will be discussed in today’s key addresses and panel sessions. First and foremost, the main question in 2020 will be how far we can get and how fast we can move in agreeing a new and ambitious trade relationship between the EU and the UK and the degree of alignment on financial services therin. We economists all know very well: a key factor in explaining trade patterns and trade intensity is geographical proximity. Of all the possible consequences of Brexit – and they are many! –the geographical position of the UK is not one. Nothing will change that. The distance between Dover and Calais remains 33 kilometers. Or to be precise: 33.3 kilometers between the white cliffs of the South Foreland near Dover, and Cap Gris-Nez in France. However, regardless of our close geographical proximity, the political decisions that will be made over the coming period will be key in determining the nature and volume of future EU-UK trade. For example, trade between the EU and the UK could drop by an average of 20% in the years after a possible no-deal Brexit.1 Indeed, in economic terms there may be little difference between a no-deal Brexit that could have occurred on the 31st of January, and a hard Brexit that could still occur at the end of 2020. This would happen if the EU and the UK are unable to agree on a timely trade deal. And if there is no mutual consensus on extending the transitional period beyond 2020. And even if a timely trade deal were to be reached, it is unclear whether services would be part of such an agreement. In short, even though we have now avoided a no-deal Brexit at the end of this month, we still face continuing uncertainty well into 2020. Because we still do not know what the relationship between the UK and the EU will look like from next year onwards. As a central banker and supervisor, I am responsible for the financial sector and financial stability. So from my perspective, a deep and comprehensive trade-deal, including services, would be preferable. Trade in financial and non-financial services is also particularly important to the Dutch economy. In 2018, Dutch services exports to the UK amounted to 23.8 billion euro.2 Of course, in practice much would depend on how far the UK is willing to align with EU regulation post-Brexit. I think the case for this is strong, for example in relation to financial services. First, much of EU post-crisis regulation has been shaped to a significant degree by UK regulators, supervisors and politicians. This would give them an important stake in upholding those rules post-Brexit. Second, — and this is also one of the panel discussion topics of today — it is in the interests of the City of London to align sufficiently with EU regulation. This is because it will directly impact the extent to which financial services can continue to be provided to EU customers from London. London is — and under all scenarios will probably remain — one of the world’s most important financial centers for the foreseeable future. However, as a consequence of Brexit, we have seen UK firms move to several EU financial centers. These firms wanted to be safe in the knowledge that they could continue to serve EU customers. Frankfurt, and to a lesser extent Dublin and Paris, have attracted bank operations from the UK. Asset management firms are moving to Luxembourg. Amsterdam has attracted a substantial number of trading platforms and payment providers. How far this trend will continue will largely depend on the future trading relationship between the EU and the UK. As I said, concluding a new trading relationship will be a major challenge in 2020. Other challenges go far beyond the 2020 horizon, and also transcend the future trade relationship between the EU and the UK: Tackling climate change is one of the key challenges of our lifetimes. This will be the second key theme of today’s conference. DNB Economische Ontwikkelingen en Vooruitzichten, 16 December 2019, p. 23. https://www.cbs.nl/nl-nl/nieuws/2019/11/verenigd-koninkrijk-derde-bestemming-dienstenexport As you know, much of the Netherlands lies below sea level, so our country is particularly vulnerable to rising sea levels. But large areas of the UK are vulnerable to rising sea levels too, including parts of London. Not to mention more flash flooding and coastal erosion. The increased frequency of severe weather events such as heatwaves and storms will affect both the UK and the EU. After all, climate change knows no borders. We collectively face the consequences of climate change and this calls for collective action. From the very start, the UK has been an inspiring companion in joint efforts to tackle climate change by putting climate-related risk on the agenda of central banks. And in supporting the growth of the green finance market. At the initiative of the Banque de France, eight central banks established the Network of Central Banks and Supervisors for Greening the Financial System at the Paris “One Planet Summit” in December 2017. Both the Bank of England and DNB were part of this initial coalition of the willing. Since then, this network has grown to 54 Members and 12 Observers representing 5 continents. The Bank of England greatly contributed to the achievements of the Network for Greening the Financial System and the rapid expansion of its membership. And the Bank of England will undoubtedly continue to contribute to the important work of the network in the future. The importance of EU-UK cooperation on climate change, of course transcends the efforts of this network. We also need global and aligned action to limit our carbon emissions and to minimize the effects of climate change. As carbon prices increase over time, coordination between countries becomes increasingly important to ensure a level playing field for carbon-intensive sectors. I hope today’s discussion can provide further insights on the role that academics and central banks can play in this respect. And I trust that the EU and the UK will continue to collaborate closely on this, given that we clearly have a shared interest in doing so. Likewise, the third topic of today’s conference – regional economic inequality – is clearly also a subject that transcends the topic of Brexit. Nonetheless, the lack of regional economic opportunities may not only have contributed to the UK’s Brexit-vote, but Brexit itself will also impact regional economic prospects. Not just in the UK, but also within the Netherlands and other EU countries. For example, a study by the Netherlands Environmental Assessment Agency, shows that – in the event of a no-deal Brexit – the regional impact in the Netherlands differs significantly: regions in the Netherlands with relatively less economic activity, will probably take a bigger hit.3 The European Union has several policies and programs in place to support regional economic development, such as the European Regional Development Fund. Brexit will not make it easier for the EU and the UK to cooperate in addressing the challenge of tackling unequal regional economic opportunities. However, https://www.pbl.nl/publicaties/korte-termijn-gevolgen-van-de-brexit investigating and implementing effective ways to tackle regional inequality, remains a shared interest to all of us. Let me conclude by stressing that while the UK will now leave the EU, other alliances between the continent and the UK will remain in place. Central banks and supervisors on both side of the Channel will continue to coordinate our efforts in the IMF, the FSB, the BIS and other standard-setting bodies. EU-UK cooperation within the Network for Greening the Financial System demonstrates that our combined impact is greater than the sum of our individual contributions. And new alliances between the EU and the UK will no doubt emerge in the future. Specific alliances may change over time, but the most important challenges facing the EU and the UK will continue to bind us. Indeed, ultimately, we will always be only 33.3 kilometers apart. I wish you all an inspiring day and thank you for your attention. | netherlands bank | 2,020 | 1 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the GLEIF Meet the Market Event 2020, Amsterdam, 4 February 2020. | “The Value of the LEI for Identification in Digital Processes” Speech by Klaas Knot at the GLEIF Meet the Market Event 2020 Amsterdam, 4 February 2020 This Meet the Market Event was hosted by the Global Legal Entity Identifier Foundation (GLEIF) and organized in coorperation with DNB. In his opening address, Klaas Knot outlined the background to the Legal Entity Identifier (LEI), and described the valuable role it can play in managing financial risks and enhancing the quality and accuracy of financial data. Mr Knot also emphasised how authorities and market participants alike can reap the benefits of more widespread adoption of the LEI. Good afternoon, and welcome to 5-4-9-3-0-0-1-O-3-6-C-V-K-P-V-L-2-D-4-8. In other words, welcome to De Nederlandsche Bank. Of course, it is easier to call this place by its name. And not by its 20-character alpha-numeric code. But the Legal Entity Identifier – in short, LEI – is a valuable initiative and that is what we are here to discuss today. Before we do, let me share a bit of background, from my perspective about how and why the LEI was developed. And how you can play an important role in further expanding its use. Thereby making the financial system a little bit safer one LEI at a time. Like many other regulatory innovations, the LEI was born out of the global financial crisis. The years leading up to the crisis saw a diverse range of legal entities trading on financial markets. Many of them were also part of much larger firms, even though this was not always clear. These financial conglomerates combined many different structures and activities. And they operated across many different jurisdictions. But they also lacked transparency and stability. Lehman Brothers was a prime example of this: a patchwork of cross-border and cross-entity interdependencies. Lehman’s insolvency resulted in over seventy-five separate bankruptcy proceedings. When it collapsed, the group was party to over nine hundred thousand derivatives contracts. When the crisis hit, it was unclear which party owed what to whom. The resulting insecurity caused even more panic on the financial markets. The root of the problem was the large number of legal entities, scattered across the world, with no uniform international method of identification. The LEI was therefore introduced to address this problem and in 2012, the G20 endorsed the LEI System as a global standard. The objective of the G20 is the “global adoption of the LEI to support authorities and market participants in identifying and managing financial risks”. Since it was introduced, over 1.5 million entities in over 200 countries have registered for an LEI. The LEI has seen widespread adoption in several financial markets most notably in the over-the-counter derivatives markets. It is also used increasingly in the issuance of debt and equity securities in jurisdictions. In other areas, the uptake of the LEI is less widespread, and the Financial Stability Board (FSB) continues to monitor this progress. In line with the G20 recommendations, the FSB is a strong supporter for a broader uptake of the LEI. We see many benefits not just from a regulatory perspective. The LEI has helped to make the financial system safer. Authorities can use it for many different regulatory purposes. They can for example use the LEI to monitor financial risk, to keep track of financial entities’ aggregate risk exposure, for resolution planning. A good example is embedding the LEI in the data on derivative contracts reported by trade repositories. This is very helpful in giving supervisors a clear picture of what is going on. The LEI has also led to many improvements in the quality of data, and therefore in the quality of data analysis. This opens up possibilities for research and data aggregation. It also improves the accuracy of data reporting, and makes data more internationally comparable. The LEI is now being used in international stress tests. It is invaluable in helping to understand interconnectedness. It has improved our understanding of the build-up of risk across multiple jurisdictions. These benefits are not only available to regulators and other authorities. Obviously, these advantages are also available to the wider financial industry and academics. Looking ahead, I am convinced the LEI will play an increasingly important role in anti-money laundering processes. Banks in Europe are investing heavily in ways to combat illegal money flows. This begins with knowing your customer. The LEI not only significantly reduces the time and administrative burden required for customer onboarding. It also ensures firms are able to clearly and unequivocally know their customers, and to keep track of their financial identity. Not to mention the role the LEI can play in removing unnecessary complexity from business transactions. There are many other benefits. And these will multiply as new applications are discovered and developed. Today’s event is all about finding these benefits in the various areas of finance in which you are active. Only by convincing market participants of the benefits of the LEI, will they be encouraged to contribute to its more widespread use. It is clear that the LEI offers many benefits and has widespread support. Some of you have been working with the LEI from the outset and are strong advocates. However, it still has far to go to meet the G20’s objective.The FSB conducted a peer review last year to assess the current adoption and use of the LEI. It came up with four sets of recommendations to support the broader use of the LEI. Firstly, FSB jurisdictions should require the use of LEIs for the identification of legal entities in data reported to trade repositories. This is a strategy that is already being pursued in Europe for derivatives data and starting from April also for data on securities financing transactions. Jurisdictions should also consider requiring the use and timely renewal of the LEI in reporting frameworks for a wider set of financial market participants and infrastructures than is now the case. There are many ways jurisdictions can promote the further adoption of the LEI. They should strive to make full use of the LEI so they can reap all the benefits. The FSB will monitor the implementation of this recommendation as part of its regular implementation monitoring activities. The second set of recommendations is aimed at the FSB itself. The FSB should explore the potential role of the LEI in different areas of activity. Work is currently underway to explore the use of LEI in the resolution of financial institutions and on financial innovation issues, for example. The FSB will work with standard-setting and industry bodies to facilitate LEI adoption. As well as group entities and major counterparties of global financial institutions, the LEI should also be adopted by CCPs’ clearing members to support the timely analysis of risk exposures and interdependencies. The FSB, working with other standard setters and the industry, will also promote the inclusion of LEI in payment messages. It will also consider the benefits of the LEI in cross-border payments. The implementation of the ISO 20022 standard will be a major step forward in this respect. Thirdly, other relevant standard-setting bodies and international organizations such as the Basel Committee and the IMF should review ways to further embed or enhance references to the LEI in their work, which could facilitate the implementation of relevant LEI uses for both authorities and market participants. The fourth set of recommendations is aimed at the LEI Regulatory Oversight Committee and the Global LEI Foundation. The FSB recommends that they consider improving the LEI business model to lower the cost and administrative burden for entities. They should also consider data quality enhancements to increase the reliability of LEI data and augment the scope and usability of Level 2 relationship data. The FSB also recommends that the Global LEI Foundation works with industry and the public sector to raise awareness of the benefits of the LEI. And it is against the background of that recommendation that we are here in Amsterdam. Let me conclude. With over 1.5 million organizations around the world now registered, the Legal Entity Identifier has proven its value as the “one identity behind every business”. We have seen its benefits in different regulatory uses, for data analysis and increasingly for tracing financial flows. Yet the benefits should be reaped even more broadly. The FSB has published a set of recommendations in order to meet the G20’s objective. I am convinced the use of the LEI will expand in the coming years. Beyond securities and derivatives trade reporting, and into other sectors. Because in a globally operating financial world it is clear we need global standards. This afternoon we have the opportunity to discuss how we can facilitate the further adoption of the LEI. And to identify all the other valuable benefits it can bring. I hope everyone here today will seize that opportunity. I wish you all a very interesting and productive afternoon. Thank you | netherlands bank | 2,020 | 2 |
Contribution by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, during a satellite event of the 11th edition of the Petersberg Climate Dialogue " Financing Climate Ambition in the context of COVID19", 29 April 2020. | Fout! Onbekende naam voor documenteigenschap. A green light to lead us on the path of economic recovery Contribution by Frank Elderson during a satellite event of the 11th edition of the Petersberg Climate Dialogue: Financing Climate Ambition in the context of COVID19 29 april 2020 Frank Elderson participated in the virtual Petersberg Climate Dialogue side event ‘Financing Climate Ambition in the context of COVIDー19. In his contribution he pointed out three ideas that he thinks are important in order to shape our thinking in terms of recovery measures that should be taken. Fout! Onbekende naam voor documenteigenschap. It is a great honour for me to be on this distinguished panel and to join this wonderful conference. No doubt, at this moment the first priority of governments is halting the spread of the COVID-19 virus. That having been said, the climate crisis has not just suddenly disappeared. The droughts, the floods, the fires, the famine, the refugees, biodiversity loss: unfortunately they are all still there. At this moment, all around the world, unprecedented stimulus packages are being implemented to keep economies afloat. These amounts run into billions and trillions. The priority is to of course limit the economic impact of the pandemic crisis unfolding in front of us. That said: Are we going to blindly return to our brown past? Are we going to massively invest in what will, to a large extent, turn out to be stranded assets? If you allow me to put it even more bluntly: are we, in ill-directed attempts to restore the old economy, going to continue to destroy the planet by locking in a 3 degree scenario? Are we going to squander the very last chance we might have to avoid catastrophic climate change? Of course we should not, of course we must not. And after this conference, I hope and trust we will all say: of course we will not. In that vein, I would like to point out three ideas that I think are important in order to shape our thinking in terms of recovery measures that should be taken. The three concrete ideas I would like to share are: Think about public investments. The links that should be made with the climate agenda that is already there. We should frontload already identified green investment programmes such as the EC Green Deal and the Climate Agreement in the Netherlands and many other programmes that are already there. We should make sure that public investment is linked as tight as possible to our climate goals, or more generally to the SDG’s. Secondly, state aid measures – There are certain sectors in the economy, let me mention aviation that will qualify for state aid. It would be a historic error if we were not to make this aid conditional upon them moving towards a more sustainable future. There is a clear example, after the financial crisis in 2008, President Obama made state aid to car manufactures dependent on them moving towards the electrification of motor cars. That is an example that could now be leveraged on and can be used much more widely. Third, the pricing of CO2 exposures. This has already been pointed out over the last years many, many times, but it is now more important than ever. What we see is that the ETS price in European Union has now decreased 30%. As of course economic activity has decreased, emissions have decreased as a consequence and therefore demands of emission rights have decreased as well. Hence this decrease in price. What we need to do is give CO2 pricing more teeth. We could think of a floor in the carbon price, we could lower the allowed emission ceilings, we could strengthen the market stabilization mechanism. And we should also phase out harmful subsidies that in fact subsidize carbon intensive sectors, while what we need to do is the exact opposite. Turning now to the work of the Network for Greening the Financial System. There are 65 central banks and supervisors from all over the world who are members of the NGFS and there are 12 observers that are doing much more than just observing; they are very active. The IMF, World Bank, BIS, OECD and many more. What the membership of 65 in practice means is that three quarters of all the worlds systemically relevant banks, two thirds of all the big insurance undertakings, are being supervised by the membership of the NGFS. This gives us tremendous leverage on the financial sector. The members have a large set of instruments to ensure that what is being said is also being done. The NGFS will soon release several reports that will help our community of central banks and supervisors take the necessary measures to foster a greener financial system. One is a guide for supervisory practices. We have looked around the NGFS membership and beyond at what supervisors are now already doing in terms of how they supervise financial institutions on ways of managing their climate-related and environmental risks. We have compiled in this guide best Fout! Onbekende naam voor documenteigenschap. practices that we have found and we hope that it will help other supervisors to implement these best practices and hence — via the leverage that membership has — it will have an effect on banks and insurance undertakings all around the world. Secondly, this work is spearheaded by the Bank of England, the NGFS focuses on climate-related stress testing, developing reference climate policy scenarios for central banks and supervisors and giving guidance for central banks and supervisors on how to integrate climate risk analyses into macroeconomic and financial stability surveillance, seizing the macro financial impact of these risks. As climate-related risks are nonlinear, will to a large extend manifest themselves in the future and can therefore not be based on historical data, we need to develop forward looking risk management techniques. The third piece focuses on data gaps and disclosures. Wrapping up, in the run up to COP26, I really want to applaud the COP26 for making the very explicit connection with the financial sector, given the crucial importance of managing financial risks. I want to offer that the NGFS stands ready to do all we can to contribute. Second, I want to point out the great importance of any financial institution which is not already doing so, to incorporate in the DNA of their financial risk management, the physical and transition risks related to climate change, and even broader to environmental change, biodiversity change, SDG-related change. Any financial institution should make sure it has this long-term view and incorporate it into risk management. Coming back to the pandemic. People are dying because of the pandemic. The planet is perishing because of unwise policies from us, the people. There is a public health crisis, but there is also a planet health crisis. The planet also needs intensive care. This is the time to apply the lessons drawn from our past mistakes. This is the time to turn the page, this is the time to invest once and for all in a truly sustainable economy. In these dark days of the pandemic, we must create an avenue of hope, we must switch on the light. Let that light be green. | netherlands bank | 2,020 | 5 |
Opening remarks by Mr Klaas Knot, President of the Netherlands Bank, at "Virtual session with Klaas Knot: the economic impact of COVID-19", organised by Danske Bank, 21 April 2020. | Fout! Onbekende naam voor documenteigenschap. “Entering and exiting the frozen-state economy” Opening remarks by Klaas Knot at ‘Virtual session with Klaas Knot: the economic impact of COVID-19’ organised by Danske Bank, 21 April 2020 In his introductory remarks, Klaas Knot said that the outbreak of the coronavirus first of all represents a global health crisis. At the same time, its consequences are manifesting themselves as an unprecedented shock to the world economy. Large parts of our economies have been frozen. Many challenges will unfold on the road to a new normal, which itself is still distant and undefined. It is also clear that central banks within their mandates stand ready to play their part in mitigating the adverse economic consequences of this global crisis. Introduction Thanks to the organisers for asking me to share with you my take on the macroeconomic consequences of the global outbreak of the coronavirus. It is clear that the outbreak and spread of the coronavirus first of all represent a global health crisis. At the same time, its consequences are also manifesting themselves as an unprecedented shock to the world economy. Societies that thrive on interconnectedness have been put on lockdown, bringing large parts of the economy to a standstill. How our economies will be affected over the longer term is still unclear. At the moment, we do not even know whether this will mainly turn out to be a demand or a supply shock, let alone that we can say something about the size of these shocks. Irrespective of the many unknowns, the immediate economic policy response has been decisive and comprehensive. However, many policy challenges remain. Today, I will focus on some of these challenges that will manifest themselves over different time horizons of the current crisis. And I will conclude with some reflections that will be relevant for monetary policy specifically. First phase: Entering the frozen-state… For the duration of the acute health crisis, the global economy has been put in a state of cryopreservation. In layman terms: large parts of our economies have been frozen. In these circumstances, it is difficult to think of the concept of stimulatory economic policies. Such policies might even be inconsistent with the lockdown, as we need to slow down society to relieve the pressure from our overburdened medical systems. Instead, policymakers have engaged in large-scale preservation policies. To maintain as best as we can the delicate frozen state of the economy and prevent as much as possible permanent damage. Fout! Onbekende naam voor documenteigenschap. Such that we can gradually unfreeze our economies once the health crisis is under control. For this, we first of all need liquidity: targeted, temporary, yet ample in the broadest possible sense. Any bankruptcy of a solvent, but temporarily illiquid firm, bank or even government is a waste, and needs to be avoided wherever possible. Across the world, we have already made major progress on this front. Central banks have stepped in, providing liquidity to the financial sector and preserving government’s favorable access to finance. Governments have helped to facilitate the flow of credit to firms, through measures such as credit guarantees. Beyond liquidity support, in multiple countries short-time work schemes have been helpful in preventing mass lay-offs. In some cases, also direct transfers to small firms or independent contractors are helping them survive the crisis, without the commensurate build-up of debt levels. Second phase: …and exiting it All of us are looking forward to the moment when lockdown-measures can be eased. However, we should not underestimate the challenges associated with this exit. It will likely be gradual, and might very well be of a two steps forward, one step back nature. Its effects on the economy will likely be heterogeneous, too. Some sectors are relatively well-equipped to function in a frozen economy, and will have no trouble resuming business. Other sectors might be able to (partially) catch-up on lost revenues as soon as the lockdown eases. However, numerous sectors will experience longer-term headwinds from a social distance economy, a “1.5 meter economy” as we call it in the Netherlands. As, over time, liquidity problems translate into solvency problems, a share of firms may unfortunately not survive, in spite of all the policy measures. Moreover, many sectors will experience that, as a consequence of the crisis, the total earning capacity of our economy will have shrunk, while debt levels have increased. Challenges of diverging resilience in the recovery phase These challenges also translate to the country level. Even when restricting myself to the members of the euro area, there are clear differences in starting positions, which translate into diverging levels of resilience. Public debt levels vary widely across Member States. Debt levels range from close to non-existent in Estonia, to 175% of GDP in Greece, though we know that headline number to be somewhat inflated. Of course, while public debt levels offer a useful indicator of the fiscal space governments have available to fight the crisis, they are a narrow indicator of countries’ overall resilience. This also depends on other factors, such as growth potential and household and corporate debt levels. These also differ widely across the euro area. Looking at banks, we know that, in terms of capital buffers, banks are in a better position than in 2008. Yet, the banking sector remains heterogeneous. Non-performing loans as a share of total loans outstanding, for instance, still vary significantly across countries. This is a legacy of the previous crisis, which we will need to keep a serious eye on to prevent new problems from emerging. The diverging resilience of households, firms, banks and governments implies that there is no onesize-fits-all policy advice as to how best preserve and restore the economy. In some cases, it might be possible to tap into the balance sheets of stronger sectors, to help the weaker ones. Such withincountry solidarity can be welfare-enhancing but will not always be possible, or sufficient. Moreover, we Fout! Onbekende naam voor documenteigenschap. need to carefully guard the stability of our financial system. No-one benefits when the coronavirus crisis evolves into a financial crisis. This implies that we need to be cautious with, for instance, proposals for large-scale debt forgiveness. Such proposals are only viable when financed by governments. A pan-European policy response is needed to help the hardest-hit countries. Recent policy announcements offer a step in the right direction, but this crisis is clearly not one that will be solved overnight. Global economic challenges in the new normal Beyond the recovery phase, the coronavirus might also change the behaviour of economic agents, affecting the structure of the global economy more fundamentally. One particularly relevant example concerns global supply chains. In today’s world very few companies produce their products from start to finish. Instead, the production process is highly fragmented and takes place all over the world. This design of the global economy has enabled companies around the world to specialise and has created efficiency gains. The coronavirus, however, also shows how vulnerable the global economy has become due to firms’ reliance on these highly fragmented global supply chains. A shock in one country can disrupt the entire supply chain, especially as countries nowadays rely more on just-in-time delivery and therefore hold lower inventory stocks. Hence, the virus could give further impetus to the recent trend of deglobalisation. Although I am certainly not supportive of some of the protectionist drivers of this trend, it is not inconceivable that companies will reconsider their dependence on one specific supplier or country and diversify or even re-shore their production process. Notably, a trend of reshoring was already triggered before the coronavirus due to digitalisation, as this enables companies to reduce the costs of producing at home. For critical products it is likely, and perhaps even desirable, that companies will keep larger stocks or increase domestic production capacity going forward. In addition, authorities may engage in policy measures that have an impact on global value chains. For example, the Japanese government has already reserved the equivalent of 2 billion euros to encourage companies to bring back production to their own country and reduce their reliance on supply chains. If sustained such measures could have a long-lasting impact on global trade and, hence, global economic activity. Reflections for monetary policy Clearly, all phases that I have outlined also come with important policy challenges for central banks. As discussed, in the preservation phase, the brief for monetary policy is fairly straightforward. Our policy is directed at maintaining favourable financing conditions for households, firms and governments, to mitigate any amplification of the ‘corona shock’ through financial channels. However, the challenge does not stop there. Monetary policy will likely need to continue to play an important role in the recovery phase. Private sector activity is expected to recover only gradually. Not only because restrictions will be removed slowly. But also because economic uncertainty is likely to Fout! Onbekende naam voor documenteigenschap. linger as long as a vaccine is not yet available and the possibility of a renewed lockdown remains. The negative effects of the virus outbreak on aggregate demand might thus be quite persistent. Simultaneously however, firms will need to adjust production processes and business models to a 1.5 meter economy, which will have an effect on productivity and perhaps also on wage and price formation. This, together with the potential slicing up of global value chains, amounts to the negative supply shock I alluded to. As of yet, it remains unclear whether demand or supply effects of the corona-outbreak will dominate. The effects of the virus outbreak on medium-term inflation therefore also remain unclear. Finally, how the corona crisis will affect longer-run underlying trends in the global economy is even more uncertain than the challenges in the preservation and recovery phase. Yet, experiences from recent decades teach us that secular trends - such as globalisation - can have a substantial impact on both inflation and the wider economy. This is something central banks will need to adapt to in pursuit of their mandates. It is also something the ECB might take on board in its – postponed – strategy review. Let me summarise. We are confronted with an unprecedented degree of uncertainty with respect to the economic impact of the coronavirus crisis. Many challenges will unfold on the road to a new normal, which itself is still distant and undefined. At the same time, it is clear that central banks within their mandates stand ready to play their part in mitigating the adverse economic consequences of this global crisis. Thank you for your attention. Fout! Onbekende naam voor documenteigenschap. | netherlands bank | 2,020 | 6 |
Speech by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, at the OECD Committee on Financial Markets Webinar, 1 July 2020. | Fout! Onbekende naam voor documenteigenschap. “We should aim for a 1,5 degree economy when designing the recovery path” Speech by Frank Elderson at the OECD Committee on Financial Markets 1 July, 2020 Fout! Onbekende naam voor documenteigenschap. Introduction I am honored to open this session today. In the past 5 years, I gave more than 50 official speeches and even more informal presentations at numerous occasions, but I have never spoken in an OECD-setting. I am therefore very happy to make my debut here today on this important topic of resilient recovery. It is still very much unclear how our economies will be affected over the longer term by the virus. We do not even know whether this will mainly turn out to be a demand or a supply shock, let alone that we can say something about the size of these shocks. We are still far from the recovery phase. We just entered the phase in which many economies are slowly restarting. This exit will not be easy. It will be gradual, and might very well be of a two steps forward, one step back nature. The recovery path will very much depend on whether we are undergoing a temporary or permanent shock in the sense we need to adjust to a “1,5 meter economy”. Irrespective of the many unknowns, we should aim for a 1,5 degree economy when designing the recovery path. I fully realize that containing the pandemic has the highest priority right now. But as we consider the next stage of recovery, we must look beyond mitigating the immediate effects and think more strategically about how we recover. The economy should not only be rebuild based on 1,5 meters but also on 1,5 degrees. Today I will briefly discuss why this is important and what needs to be done. Green recovery: why is it important? I will explain why green recovery is important by: i) looking at worldwide carbon emissions; and ii) the greenness of the stimulus measures taken so far. The International Energy Agency estimates that energy demand could decline by 6% in 2020, equivalent to the combined energy demand of France, Germany, Italy and the UK in 2019. The stunning decline in energy demand results in an unprecedented drop in global CO2 emissions. Global CO2 emissions are expected to decline by almost 8% in 2020. Such a reduction would be the largest ever, six times larger than the previous record reduction during the financial crisis, and twice as large as the combined total of all previous reductions since the end of World War II. This makes you think: do we really need to speed up the energy transition? The answer is yes. The effects of climate change are irreversible and so we cannot afford to wait. In order to limit warming to less than 1.5 degrees above pre-industrial levels, analysts estimate that global emissions need to fall close to this year’s drop every year for the coming decade. At the same time, history shows that after an economic slowdown, CO2 emissions pick up at the same, and often even higher rate. We are indeed already starting to see emissions increasing again. The pandemic has shown us one way to reduce emissions: by sweeping restrictions on daily life and massive disruption of economic activity across the globe. When rebuilding our economies, we need to take decisions to reduce emissions in an orderly way, without disrupting our economies. Otherwise the climate crisis will be tomorrow’s base scenario and, unlike Covid-19, no one will be able to self-isolate from it. In the immediate response to the pandemic, governments have taken measures of unprecedented scale to keep economic and financial systems afloat. The IMF estimates that approximately $9tn of fiscal support has been provided across the world. Following the global financial crisis, only a fraction of fiscal spending improved sustainability. This time, governments’ stimulus packages need to be more ambitious. So far, stimulus measures are understandably mainly focused on limiting acute and permanent damage to the economy and not on making the economy greener. The so-called greenness index tracks the contribution (or damage) of the stimulus measures to the environment. It shows that in 15 of the 18 countries considered, potentially damaging flows for the environment outweigh those supporting nature. As we consider the next stage of recovery, we must look beyond the immediate crisis and think more strategically about how to recover. Rebuilding the brown past, will delay a green future. It will increase the bill for future generations. And increase the physical and transition risks for the financial sector. Fout! Onbekende naam voor documenteigenschap. Therefore, we should recover from this crisis, while seeking the opportunities to make this recovery as green as possible. Green recovery: how? Since we are here today with governments, central banks and supervisors from all over the world, I will briefly elaborate on the role that we all can and need to play in the green recovery. Role of governments CO2 pricing remains the cornerstone of effective climate policy. From an economic perspective, pricing is the most effective means of reducing emissions. A key factor currently slowing down the transition is the fact that companies still have insufficient financial incentives to reduce their emissions. It is therefore up to governments to impose proper carbon pricing. While global carbon emissions are increasingly being priced, current efforts in this regard are far from sufficient. Despite growing number of carbon-pricing systems, these systems only cover 20% of global emissions. Moreover, only 1% of global emissions is priced at a level necessary to achieve the Paris objectives. Sufficient carbon pricing is now more important than ever. As economic activity has dropped as a result of corona, emissions have decreased as well and therefore demands of emission rights have decreased significantly. Hence this decrease in price. In order to achieve the Paris goals, the carbon price must be raised and the scope of current pricing mechanisms must be widened. To limit carbon leakage to countries with lower carbon prices, more ambitious carbon pricing should be combined with carbon border adjustment mechanisms. In addition to carbon pricing, governments need to integrate the necessary sustainability investments in their medium-term investment agenda. It is conceivable that governments will stimulate demand through discretionary spending. At that time, it would be wise to bring forward necessary investments in the climate transition. Investments that are clearly essential to achieving an efficient climate transition could then be used to stimulate the economy and make it more sustainable at the same time. Role of supervisors This crisis underlines the importance of incorporating the physical and transition risks related to societal and ecological challenges in the DNA of financial institutions. The crisis may lead financial institutions to reconsider their principles and policy choices regarding sustainability and climate risks, since large investors were faced with high market volatility and sizeable losses on their exposures to the oil and gas industry. A recent DNB-report reveals that the financial sector is not only exposed to climate-related risks, but also to risks as a result of biodiversity loss. Similar to climate change, the financial sector also face significant physical, transition, and reputational risk resulting from the loss in biodiversity. This study underscores that any financial institution should make sure to have this long-term view and to incorporate these types of risks into its risk management. Supervisors must make sure that they are equipped to take climate and environmental risks into account. The NGFS has just released a guide for integrating these risks into prudential supervision. We hope that— via the leverage that membership has — it will have an effect on banks and insurance undertakings all around the world. In light of the need of a green recovery, prudential risks of climate change also need to be integrated in financial legislation at an accelerated pace. In Europe, the EBA is currently exploring the possibility of including sustainability risks in capital requirements for banks. This requires quantitative insight into these risks. The analysis of these risks and subsequent decision-making must be given greater priority, not only at a EU-level but also worldwide. Climate related risks need to be well embedded into financial legislation, guidelines and accounting standards. Role of central banks Central banks can play a supporting role in the green recovery. It is up to the governments to take the first step and exploit the opportunities for green recovery through their climate policies, but as an independent organization with a long-term horizon, central banks are well-positioned to bring parties together and provide economic advice. Fout! Onbekende naam voor documenteigenschap. Central banks are also facing the challenge of incorporating ESG risks into the risk management of their own portfolios. DNB was the first central bank in the world to sign the Principles for Responsible Investing (PRI) in 2019. This requires us to better manage the ESG risks involved in our investment activities. Our charter on responsible investments specifies which actions we are currently undertaking in this respect. However, the PRI does not apply to the monetary portfolios, which are much more substantial than our own investments. In the implementation of monetary policy, climate related financial risks should also be adequately mitigated. Now that central banks’ role in financial markets and the funding of banks has increased as a result of the policy response to the pandemic, this has become ever more important. Central banks must evaluate whether current risks management measures need to be revised and whether additional measures are needed. For example, the ECB could include carbon emission disclosure as a requirement in its asset purchase programmes, to promote transparency and enable adequate risk identification and pricing. Still, the actual contribution of monetary policy to sustainability depends on the climate policy pursued by governments. Effective climate policies will lead to a greater flow of capital towards sustainable economic activities, thereby "greening" monetary operations automatically. Increased demand for green investments can lead to higher supply of green bonds or bonds from sustainable companies, giving central banks more room to purchase these instruments. The opposite also applies: in the absence of proactive climate policies, monetary expansion may favour polluting rather than sustainable industries. Closing remarks The pandemic offers a unique momentum to green the global economy. To seize this opportunity, it is crucial governments, central banks, supervisory authorities and financial institutions take firm and decisive action. All these entities have a specific role to play in achieving the Paris Agreement. As the economy still largely depends on fossil fuels, a fundamental reorientation is called for. With their climate policies, governments are the driving force behind this reorientation, but central banks and supervisors also have an important role in accelerating the transition. If we all take up the gauntlet and play our part, we will be able to overcome one of the greatest challenges of our time. As the virus developments changes from day to day, I believe it is now more important than ever that our crisis responses are aiming in the same direction and reinforces each other. Sessions like this one, in which we share our experiences and insights, are therefore extremely valuable. I am therefore keen on hearing your thoughts and views, so I am opening the floor for questions and the next speakers. | netherlands bank | 2,020 | 8 |
Text of the HJ Schoo lecture by Mr Klaas Knot, President of the Netherlands Bank, Amsterdam, 1 September 2020. | Fout! Onbekende naam voor documenteigenschap. “Emerging from the crisis stronger together” How we can make Europe more resilient, prosperous and sustainable HJ Schoo lecture given by Klaas Knot Amsterdam, 1 September 2020 Fout! Onbekende naam voor documenteigenschap. Ladies and gentlemen It is an honour to give this year's HJ Schoo lecture. I have to say, it was a bold choice from the organisers to let me loose on you for an hour. There's a YouTube video doing the rounds of me being interviewed on the current affairs programme Buitenhof. While I'm talking, text appears below explaining what it is I am actually saying. A bit like subtitles. Unfortunately, that is not a luxury I can offer you this evening. But I will try to keep the economic jargon to a minimum. Even though you seem like an audience who can keep up. I never knew Hendrik Jan Schoo personally, so in preparing for this lecture, I went a bit deeper into the man and his work. And as I was reading about him, I started wondering how he would have felt about me—a President of De Nederlandsche Bank— being chosen to give the lecture called by his name. Schoo was primarily a political thinker, with an acute sensitivity to the deeper currents running through society. Economics did not feature prominently in his work. But there was something else that struck me about Hendrik Jan Schoo. And here I will quote from Marc Chavannes’s description of him: “Schoo was a selfmade man, from an everyday background. Reluctantly absorbed into the elite, he remained overtly concerned about the risks ordinary people face.” That last sentence resonated with me, because I realised that also fits my job description. “Managing the risks ordinary people face.” Or, to be more precise: managing the financial risks ordinary people face, over which they have no control themselves. Because make no mistake. What central banks do directly affects your life and that of everyone else around you. They ensure prices remain stable. That banks, insurers, pension funds and other financial institutions are sound and ethical. And that you can make payments efficiently and securely. So the economy can flourish and ordinary people can make a living, safe in the knowledge that their money will retain its value and is protected. My own economic coming of age happened during the deep recession at the beginning of the eighties. I was a youngster of about 15, and evening after evening I would watch news reports about the bankruptcies. Unemployment and inflation had skyrocketed, and the hole in public finances kept getting deeper. I also saw the consequences for society, sometimes up close. Falling prices on the housing market meant the mortgage on my childhood home was ‘underwater’. I still remember very well the stress that caused my parents. How can an economic system get so out of control? The question fascinated me. It was the beginning of my lifelong interest in economics. And now once again, we find ourselves in an economic maelstrom, but this time under unprecedented circumstances. One glance around this room is enough to see that. The pandemic has pushed the global economy into deep recession. The Dutch economy has also suffered a heavy blow. Fortunately, the Dutch economy has a strong foundation. As Dutch Finance Minister Wopke Hoekstra so aptly put it, the government entered the crisis with deep pockets. This allowed it to absorb much of the blow for households and businesses. And thanks to their robust capital buffers, banks have the room to continue lending. This shows why it is so important to build up buffers in good times. Yes, De Nederlandsche Bank is singing the same old tune again. I am sure you recognise it. But, as one of my predecessors once said: the old tunes are often the best. Our economy's strong foundation means we will also ultimately recover from this crisis. But I am honestly more concerned about Europe. The European economy is expected to contract sharply this year. The ability to recover from such a blow is certainly not equal in all European countries. I am particularly concerned about the southern member states. Not only because most of them have been hit by the coronavirus. But also because these countries’ economies had already been struggling for over a decade. What we have seen in recent months is that the debate quickly turns to the future of the euro. That is bad news for Europe. All this raises some important questions. Questions I would like to address together with you this evening. Why is it that economic shock waves, such as the banking crisis of 2008 and now the coronavirus crisis, are constantly throwing European cooperation out of balance? And how can we make Europe more resistant to these types of shocks, not just in view of this crisis, but with an eye to the future? Fout! Onbekende naam voor documenteigenschap. Ladies and gentlemen, I will highlight why there is a tendency in Europe towards economic divergence between north and south. I will show you how we still benefit greatly from European cooperation. But also that we have to do something to correct the imbalances if we are to preserve the advantages. I will argue that we can do something, by finding common responses to common challenges, and through enhanced coordination of economic policy between the north and south. That is by no means straightforward, but it is indispensable for a smoothly functioning monetary union and a strong Europe, in the interests of sustainable prosperity for ordinary Dutch people. In other words, emerging from the crisis stronger together. The challenges facing us I’d like to start by saying something about the economic advantages Europe has given us, and continues to give us. [Figure 1] Figure 1: Emigration. Waving off departing family members as their boat leaves port. I think you will recognise this sort of archive photo. An ocean liner. People on the quayside, waving off family and friends, sometimes flapping a handkerchief. The archetypal image of post-war emigration. In the period from 1945-1967 around half a million Dutch people left these shores for countries such as Canada, America, Australia and New Zealand, in search of a better life. They were not the only ones. In the years following the Second World War several million Europeans left the continent. And with good reason. In 1947 the outlook for Europe was sombre. The continent was financially devastated, everything was in short supply, and reconstruction efforts were slow to develop. The outbreak of the Cold War paralysed European politics. Europe was perhaps very close to becoming a failed continent. But fortunately, history took a different course. Europe focused on emerging from the ruins of two world wars and decades of bitter division to become one of the most free and prosperous places on Earth. We have by now become so used to this, that we sometimes forget what an astonishing feat it was. And that astonishing European feat, ladies and gentlemen, is in no small part thanks to European cooperation. Take the European single market, the whole body of rules that facilitates the free movement of people, goods, services and capital. There has been considerable research into the benefits of the single market. Two conclusions invariably emerge from these studies: the first is that each member state benefits from the internal market, and the second is that small, open economies, such as the Netherlands, benefit the most. That is what you can see here in the graph. [Figure 2] Fout! Onbekende naam voor documenteigenschap. Figure 2: Estimated benefits of the single market, in EUR per household Taken together, the studies show that membership of the single market benefits households in the Netherlands by between 6,000 and 10,000 euros every year. Even when we take into account the Dutch contribution to the EU budget, there are still substantial welfare gains for the Netherlands. In other words, in the Netherlands we have the European single market to thank for a big piece of our pie. But you may now ask: how about the euro, our common currency? How does that balance out? As you know, the creation of the euro was primarily a political project. Discussions on economic and monetary union gained momentum after the fall of the Berlin wall. Germany once again became a unified nation. The other European partners, principally the French, were keen to ensure the reunified Germany stayed embedded in a united Europe. That was the deal that Mitterrand made with Kohl: unification for you; the euro for us. As well as political reasons, there were also strong economic arguments in favour of a common currency. A single market like the European market, where there is intensive trade between countries, benefits from fixed exchange rates. This reduces uncertainty surrounding foreign investments, and makes it easier to compare prices between states. And in turn, that promotes competition and trade. The success of the single market is therefore built on the bedrock of the euro. But a single currency also unfortunately brings disadvantages. Certainly for a group of countries that differ quite a bit from each other economically. For example, one common currency means one common rate of interest, and that rate is not always suited to each country. This can contribute to the build-up of debt, or to rocketing house prices. Irreversibly fixed exchange rates do not just offer stability, they also imply that countries can no longer use their exchange rate as a way to restore their competitiveness. Partly because of this, not all euro area countries have benefited equally from the euro. To put it bluntly: countries with stronger economies, such as the Netherlands, have benefited more than countries with weaker economies. So why does a common currency work in favour of stronger economies? Allow me to explain. To do so, I will use the Netherlands and Italy as examples. Exchange rates between euro countries were frozen, as it were, when the euro was introduced in 1999. Since then, productivity growth in has been higher in the Netherlands than in Italy. This is what economists refer to when they talk about 'stronger' and 'weaker' economies. Productivity growth means you can make more or better products with the same means of production and thus offer better value in terms of price to quality. In order to keep Italian products competitive with Dutch products, the Italian currency would have had to depreciate against our Fout! Onbekende naam voor documenteigenschap. currency. As a result, Italian products would become cheaper. Before the guilder and the lira became irreversibly linked, we regularly saw this kind of depreciation of the lira. But that is of course no longer possible now. You can see that very well in this graph, which shows the exchange rate of the guilder against the Italian lira.[Figure 3] Figure 3: Historical exchange rate of Dutch guilder against Italian lira. At the beginning of the 70s you needed nearly 6 guilders to buy 1,000 lire, but in 1999 you could get 1,000 lire with just over 1 guilder. As long as Italian productivity growth lags behind Dutch growth, the only alternative is for Italian wages to also lag behind Dutch wages. But our wage growth is already only very modest. That would imply that there is virtually no more room left for wage growth in Italy. And with our in-built tendency to resort to wage moderation at every recession, Italian wages even need to be reduced from time to time. Wage cuts in other words. Economists are good at coming up with these sorts of pure, conceptual solutions. But do you remember the weeks of protests in the early 1980s, when the first Lubbers cabinet cut public sector pay? When trash was piled high in the street? Cutting monthly income simply causes practical problems, and that applies just as much to Italians as it does to the Dutch. Thanks to the euro, the Netherlands has enjoyed a stronger competitive position than if we still had our own currency. Compared to southern Europe, but also compared to the rest of the world, thanks to the weaker euro exchange rate. And that boosts our exports. It is how we in the Netherlands obtain such an enormous trade surplus: we export much more than we import. This generates higher operating profits for business and also increases tax revenues for the Dutch State. You could say that the euro always gives a little boost not only to the Dutch economy, but also to the Dutch treasury. For a country like Italy, where productivity growth is lower, roughly the opposite applies. At the risk of oversimplification: the absence of an exchange rate between euro area countries is a benefit to the stronger economies, while it is a relative burden to the weaker economies. That is why the stronger and the weaker economies have a tendency to diverge. If this imbalance persists for too long, it will lead to problems like we saw during the 2011 European debt crisis, when several southern euro area countries experienced major financial problems. Well, you might say: “Tough luck, but that's just how it is.” Did we not agree in the Maastricht Treaty that countries in the euro area have to look after their own finances? The famous no bail-out clause. If only it were so simple. Of course, each country is still responsible for its own economy and public finances. But in 2011 we learned the painful lesson that we cannot just Fout! Onbekende naam voor documenteigenschap. abandon struggling euro area countries to their own fate. This would unleash financial forces that could bring about the disintegration of the euro. The economic and political havoc that would then arise is literally incalculable. You just would not know how it would unravel. So that is something we would definitely not want to happen. As long as the phenomenon of divergent growth exists, stronger economies will occasionally have to step in to help weaker ones. But it would be much better to tackle the root cause of this growth divergence. These differences between north and south are not after all a God-given natural phenomenon. You might be wondering: why don't these southern member states carry out reforms to make their economies as productive as in Germany and the Netherlands? Yes, well, ultimately that is what has to happen. And it is also an uncomfortable fact that in recent years many opportunities have been missed. Not only in terms of reforming the economy, but also in terms of putting public finances in order and cleaning up bank balance sheets. Building up buffers in good times, fixing the roof while the sun is shining. Yes, still the same old tune. Yet people in the north who keep grumbling about this do have a point. But you know, the Italians have a nice expression for that: se mia nonna avesse le ruote, sarebbe una carriola. If my grandmother had wheels she'd be a wheelbarrow. But now we all have a new crisis to contend with, the coronavirus crisis. And what is particularly cruel about this crisis—and I might add hazardous for Europe—is that it is precisely the countries in the euro area with the most vulnerable economies that have now also been hit hardest by the virus. That of course has nothing to do with the euro. But it does mean those countries are being hit hard yet again. Like the Netherlands, they, too, will have to intervene decisively to mitigate the effects of the coronavirus on citizens and businesses. Consequently, their government debt will rise further. And they were not in a financially strong position to begin with. As a result, there is a risk that governments in these countries already have to start introducing austerity measures before the economy has been able to recover. That would in the first instance further exacerbate the economic downturn. Take a country like Greece. At the end of 2019, Greece's public debt was already 175% of its GDP. Greece is the red bar all the way to the left of this chart. [Figure 4] Figure 4: Wide divergence of public debt in euro area countries Greece is not able to support its economy in the same way as the Netherlands. Just for comparison: 175% amounts to more than three times the Dutch public debt. So if we do nothing, we will see further divergence between euro area countries. And the risk of recurring euro area crises. But there is something else that also worries me in this respect. And that is waning Fout! Onbekende naam voor documenteigenschap. public support for the euro as a result of this growth divergence. Public support for the euro among euro area citizens remains high. That is good news. But can we take it for granted that it will stay that way? Southern Europe reaps relatively little benefit from the euro. And in northern Europe, people often feel they are being called on to bail out their Mediterranean partners time and again. Structural transfers of wealth generally spoil the atmosphere. Not only for the providers—but uncomfortable feelings of inferiority can quickly arise among receivers. You can even observe this in countries where wealth is transferred between regions. Take Belgium and Italy for example. If we also doubt the work ethic of the Italians, a country where the average worker works almost 300 hours more per year than in the Netherlands, you can imagine that this does not benefit relations. [Figure 5] Figure 5: Cover Elsevier Magazine I would like to stay on this subject of public support, because there is another potentially dangerous trend I detect in northern Europe. And that is the lagging public support for free trade in general. There is for instance a growing group of Europeans who believe that globalisation has been good for their country as a whole, but not for them personally. We can see similar developments in our own country. For example, more than one in five Dutch people think globalisation offers more disadvantages than advantages. People on lower incomes in particular feel they are on the receiving end of the disadvantages. Unfortunately, there is some truth in that. Dutch businesses have benefited greatly from free trade, the single market and the euro. For Dutch households, this applies to a lesser extent. In recent decades, household disposable income growth has not kept pace with growth in the economy as a whole. Just take a look at this graph. [Figure 6] Fout! Onbekende naam voor documenteigenschap. Figure 6: Household income grows at a slower rate than the economy The red line represents the growth of the Dutch economy as a whole since 1995. The blue line shows the available income of households. Why are these two lines growing apart from each other? Well, to a large extent it is because the share of our national income that workers receive (the labour share of income) has been steadily declining, while the share going to providers of capital has increased. Incidentally, this is not a typically Dutch phenomenon. We can also observe this trend in other Western economies. The fact that workers in the Netherlands are getting a smaller and smaller piece of the economic pie is also due to globalisation and technological progress. But there is something else going on in the Netherlands. And that is the flexibilisation of the labour market, which has gone too far. That is something that all sides can agree on. The often vulnerable position of flex workers is already a cause for concern from a social perspective. But on top of that—and now I return to my argument about Europe—it has also contributed to the fact that working people are getting an increasingly smaller piece of the economic pie. And if a large proportion of them start to see “Europe” first and foremost as a private party for businessmen, with scant benefits for their own pockets, then that will undermine support for the European project. Good. To sum up what I have said so far. The euro is a pillar of the single market, and brings us considerable prosperity. However, the euro also tends to lead to diverging economic growth within Europe. The current coronavirus crisis exacerbates this phenomenon. If we do nothing, then we run the risk of ending up in a new euro area crisis, and public support for European integration could come under pressure. In the weaker economies of southern Europe, because they do not reap enough of the benefits. And in the stronger economies such as the Netherlands, due to uneven distribution of benefits, and with it the willingness to help out southern European states. I think that is what we in the Netherlands should be worried about. Not only based on our own clear economic self-interests, but also because Europe is about so much more than the financial benefits. We see that the balances of power on the world stage are shifting. One superpower retreats into confusion, while new superpowers emerge. Unfortunately, these are not always countries which share the values we do. For many refugees, Europe is that beacon of freedom, peace and prosperity for which they are prepared to risk their lives. A sign of our strength, and at the same time a challenge for European society. And then there is still the climate crisis. If we want to realise our ambition to limit global warming to less than 2 degrees Celsius, then we will have to complete the transition to a climate-neutral economy Fout! Onbekende naam voor documenteigenschap. by around 2050. Substantial investments are required to achieve that. Investments that will get off the ground much more easily if we increase the price of emitting carbon and other greenhouse gases. In short, how are we going to make sure we emerge from this economic crisis in a more sustainable way? The shifting balances of power, the refugee crisis, the climate crisis. You don't have to be a Europhile to know that we can tackle these transnational challenges better at European level than at national level. These challenges call for European cooperation within a strong European Union. And this is inextricably linked to strengthening the foundations of our currency union. This is perfectly possible. The imperfections in the Economic and Monetary Union I outlined earlier are not like the coronavirus, which hit us out of nowhere. We created them ourselves. And that means we can also fix them ourselves, if we want to. But there are three things we need to do for that to happen. The first is to fight this coronavirus crisis collectively and effectively. European heads of state did an excellent job this summer by creating the Next Generation Recovery Fund. The second is that the countries in the currency union should better coordinate their fiscal policies, with the level of public debt playing a more central role. And the third is that we also need to better coordinate other areas of our economic policy. Now let me take you through how I envisage this. Emerging stronger from the crisis: an agenda This summer, European leaders wasted no time in setting up a European recovery fund. Their decision was an important step in the fight against the coronavirus crisis. During the public debate, comparisons were made with the Marshall Plan, the US aid programme to help rebuild post-war Europe. I think it is a very apt comparison. The elements that made the Marshall plan a success are reflected in the plan for a European recovery. The recovery fund is not emergency aid but is intended to support public investments in countries that strengthen economic growth potential. The receiving countries retain an important degree of responsibility for how the money is spent, within certain set conditions. The financing has been structured in such a way as to ensure southern European countries do not accumulate ever more debt. And the fund is big enough to really make a difference. It is also good that priority is given to investments in digitisation and making the economy climateneutral. That way we can kill two birds with one stone: we narrow the gap between those leading the way and those lagging behind, and we invest in the sustainable growth capacity of the euro area. The strength of this proposal lies not only in its collective, but also in its temporary nature. Structural transfers from one country to another can quickly lead to bad feeling, as we have seen elsewhere. That is not the case with the recovery fund. The fund is temporary, there are no direct transfers between countries, nor do countries assume responsibility for each other's debts. The recovery fund is therefore an excellent initiative. But that it is not enough, which brings me to the second item on my list. If we want to put an end to divergent growth in Europe we will also have to coordinate fiscal policy more closely. In recent years, European fiscal rules have been particularly focused on the maximum budget deficit, the well-known 3% of gross domestic product. But as a result, in practice the rules proved to be strict during bad times, and ineffective during the good times. Thus accentuating the peaks and troughs of our economy, instead of smoothing them. Moreover, there was scant attention for the differences between countries. For example, after the financial crisis of 2008, any country with an excessive deficit had to consolidate its public finances roughly all at the same pace, regardless of the level of public debt at the outset. There is one lesson I think we can take from this: we need to pay more attention to public debt levels. The Maastricht Treaty sets a public debt limit of 60% of GDP, although there is some flexibility. You can exceed this threshold, as long as you bring public debt back down to the 60% reference value. This limit must regain its prominence. It is a recognisable benchmark, and allows countries the room to temporarily increase their debt during economic downturns. However, the pace at which countries are required to return to below this limit needs to vary more than it does now, taking their individual economic situation into account. In economically more favourable times, countries with higher government debt levels should have to make greater efforts to reduce their debt than countries with lower debt levels.This does more justice to differences in starting positions, and the European economy will also benefit if all countries do not tighten their fiscal reins at the same time. Fout! Onbekende naam voor documenteigenschap. In addition to restoring the 60% limit, I believe that in reducing public debt, we should put more emphasis on reforms that promote economic growth. Rather than the austerity measures that often constrain growth in the first instance. Without robust growth, it is simply very difficult for countries with high levels of public debt to bring their debt back to a healthy level in relation to the size of the economy. We have seen that. If austerity is unavoidable, fiscal rules should at least protect public investment. This investment, for example in infrastructure, sustainable energy, education and science, has all too often fallen victim to austerity measures. Heavily indebted countries have seen the erosion of their economic growth potential due to chronic under-investment. As a result, they are left lagging even further behind. If we take another look at the Netherlands, what does this mean for Dutch fiscal policy in the forthcoming term of government? Dutch public debt is expected to increase from around 50% to 60% of GDP in the coming years. This is a sharp increase, but thanks to our comfortable starting position, we will end up at a level that is still manageable. That is why I see no reason to cut spending or raise taxes at this time. After all, our economic recovery could still be fragile in 2021. What we do need to do now is strengthen the growth potential of the Dutch economy with structural reforms and temporary, targeted investments. This is not of course a plea for unbridled growth in government spending. After all, there will always be new, unexpected setbacks. So I think it is wise to be wary of new policy initiatives that place a structural burden on government finances. This addresses fiscal policy in Europe and in the Netherlands. The third point on my European to-do list for tackling growth imbalances is to improve coordination in other areas of economic policy. I have already talked about the divergent competitiveness of the euro area member states. And how this contributes to large trade surpluses in some countries, and large trade deficits in others. To effectively tackle this problem, all member states must play their part. Weaker economies need to implement reforms that increase their productivity and competitiveness. This is good for exports, for economic growth, for employment, and for public debt. The point I want to make here is that these reforms are more likely to succeed if the stronger economies also do their fair share. For these countries, that means implementing reforms that give households more room to spend, so that they can boost imports and reduce their trade surpluses. This will not only help the weaker economies, but also benefit the stronger ones. Behind large and persistent trade surpluses, there are often underlying problems, such as savings retained by companies for tax reasons, or stagnant wage growth. If I apply that to the Netherlands for a moment, it means we also have work to do. It means we have to critically review our tax system, so that labour can be taxed less heavily and workers get to retain more of their pay. And we need to tackle the imbalances in the labour market between permanent and flex workers, by reducing tax differences between contractual employees and the self-employed. As far as I am concerned, these are the key challenges for the coming term of the government. Summing up, I have talked to you about the recovery fund, and the coordination of fiscal and other economic policies. So, have we covered everything, then? No, not entirely. There is still something else to discuss. The recovery fund that the European heads of state agreed on is a one-off and temporary solution. As I said before, I think that its strength lies precisely in the fact that it is one-off and temporary, and I mean it. After all, it is the euro area countries themselves who have primary responsibility for ensuring and maintaining a healthy economy, and consequently for the reforms and investments needed to achieve that. Northern euro area countries need to reform to bring about higher wage growth and domestic demand. Southern euro area countries need to reform to become more competitive and reduce their debt burden. But let's be realistic: this will take time. Even with the right policies in place, countries such as Greece and Italy will most likely need decades to get to where they need to be. In the coming years their levels of public debt will still be too high to weather another recession without taking far-reaching austerity measures, especially if it involves a deep euro area-wide recession. They will have to go to great lengths to maintain public investment under these circumstances. Foreign investors will not be thrilled by the prospect of a structurally higher tax burden. This means there is a risk that these countries could fall further behind again. Which would again overshadow our objective of creating a stronger monetary union. Fout! Onbekende naam voor documenteigenschap. So, we will have to find a way to deal with these situations. To be quite honest, I don't know what the best course of action is. While the recovery fund sets a relevant precedent, we have already established that structural transfers can leave a sour taste in the mouth. Another option is to allow debt restructuring within the monetary union. This means a country meets with its main creditors, such as the banks, to discuss how to reduce its debt position without jeopardising its euro membership. However, this option is not without significant obstacles either - especially since a major proportion of this debt is still concentrated with local banks. Public debt write-downs would lead to significant losses for these local banks and possibly also trigger capital flight, and consequently still jeopardise the country's euro membership. This is roughly the scenario that played out in Greece. So both options—a permanent fund as well as debt restructuring—have their own, serious impediments. As long as the issue of divergent growth is not resolved, the strongest shoulders in the European caravan will from time to time have to bear a heavier load to ensure no-one gets left behind. This will require a great deal of serious thinking in the years ahead. All in all, I believe the agenda I have outlined would put us on the way to a stronger currency union. With European governments investing in sustainable growth, both individually and working together. Through more closely aligned economic policy. Alignment implies reciprocity, and a fair division of rights and responsibilities. For us, here in the Netherlands, it would mean having to relinquish a degree of our national autonomy. I realise that is a difficult step to take. No country is prepared to give up part of its sovereignty lightly. It takes courage. And what will we get in return? The prospect of a more stable and prosperous monetary union, in which all countries equally share the costs and benefits. Where there is a positive balance of these costs and benefits in all countries. So the atmosphere is untainted by the question of who should bear the heaviest burden. Creating a stronger feeling of goodwill in Europe and for Europe, which will make it easier to tackle together the great challenges before us today. In short, well-understood self-interest. Some people will say: even closer European integration? Now, of all times? There's no public support for that, is there? To those people I say this. We could also choose not to work towards further European integration and more risk-sharing. That's also an option, certainly. But there is a price to pay for that option. The price involves increasing economic inequality between the euro countries, more debt crises, more emergency support and lower levels of prosperity. It would make the euro unsustainable. And I fear that in a globalised economy, this price would ultimately be paid, again, by ordinary people. The people with whom the eponym of this lecture was so concerned. There are people who say becoming a bit worse off is a small price to pay for greater freedom. To take back control. But is that how it really works? How much of a sovereign nation were we before the euro? When we have sold our goods abroad, haven't we always had to take our customers’ preferences into account? Our ancestors were already aware of that ages ago. These days, that means we have to take on board international rules and regulations. We see countries like Switzerland and Norway, who are outside the European Union, in many respects have to follow European rules without having a say in how these rules are made. We see countries like Denmark and Sweden, that are not in the euro area, still striving for exchange rate stability vis-à-vis the euro. That means they generally accept the euro area interest rate policy – and also contribute to the recovery fund. And finally, we now see how the United Kingdom is struggling to find the right balance between sovereignty and free trade. I believe more European integration is the right option. Will it be easy? No. Do we need more public support? Yes. So let us lay the foundation for that support. And to do so, policymakers must clearly present the pros and cons of European integration, and be open to discussion. They must take accountability for the decisions they make together in Brussels. And above all else, they must make sure the benefits of European cooperation are shared equally by everyone. Brexit has clearly shown us why this is absolutely necessary. Final observations Ladies and gentlemen. Today, the Economic and Monetary Union looks quite different from what the authors of the Maastricht Treaty envisaged back in 1992. They expected the economic differences between member states to lessen over time, thanks to the introduction of the euro and supported by public finance regulations. That did not happen. Fout! Onbekende naam voor documenteigenschap. We have drifted away from our forerunners’ expectations in a number of respects. That was inevitable. Had we decided to rigidly stick to the spirit of the Treaty during the lowest point of the crisis, we would probably no longer have a monetary union. The world around us has also changed. The significant geopolitical shifts, the enormity of the challenges with respect to climate change and refugees. This requires more cooperation at European level. All the same, we are living in a different monetary union than we imagined back in the 90s. With more sharing of risk. And more harmonisation of policy. In recent years we have pushed the boundaries of the Treaty. There is no guarantee that we will not have to do that again. So it is crucial to reaffirm the political mandate. But central bankers like me aren't the ones who have to make those decisions. It is up to politicians to state their preferences and to present them clearly to their voters. That is why I hope to see a spirited debate on the future of Europe in the run-up to the parliamentary elections next spring. If we want to achieve a strong and healthy Europe that can protect its citizens against the risks hanging over them. If we want to achieve a well-functioning Europe that works for all of us. If we want to achieve a sustainable Europe that is ready for the future, then we must be willing to do what it takes. It requires us to better harmonise our economic policies, and to jointly invest in sustainable growth. Firmly based on member states assuming responsibility for putting their own house in order. With the realisation that all member states must do their bit, including the Netherlands. And with the prospect of creating a better future for us all, ultimately. On 22 November 1989, 13 days after the fall of the Berlin Wall, Jacques Delors, European Commission President, addressed the European Parliament. He spoke of the task facing the European Community in those momentous days. He said: “Luck helps sometimes; courage helps always.” I wish you and our politicians much courage in the times ahead. Thank you *** | netherlands bank | 2,020 | 9 |
Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, at the Eurofi Financial Forum, Berlin, 11 September 2020. | Klaas Knot: Monetary policy responses to the corona crisis Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, at the Eurofi Financial Forum, Berlin, 11 September 2020. * * * A framework for central banks to assess the appropriateness of their policy decisions usually has three dimensions: necessity, effectiveness and side effects. It is important to view these dimensions in conjunction, as there are usually trade-offs involved, which may differ over time. In my introduction, I will elaborate on the dimensions and trade-offs in the current monetary policy setting. The necessity of continued monetary policy support follows from the mandate of the ECB, which states that price stability is the primary objective. It is beyond doubt that the extended monetary policy measures since mid-March have been needed to support monetary transmission and help the economy establish a foothold in the lockdown. This has contributed to avoid worst case scenarios and deflationary threats. The monetary policy responses to the corona crisis have clearly been effective. The ECB responded forcefully by employing a multitude of instruments, including the new Pandemic Emergency Purchasing Program. This has been effective in limiting the fall-out from the financial market stress and preserve the loose monetary conditions. Moreover, the targeted LTROs have been effective in safeguarding banks’ funding liquidity. Thereby, the emergency monetary policy measures have been an effective circuit-breaker to prevent bad equilibria. As we have moved to the recovery phase, the focus of the monetary measures has shifted to supporting inflation, by maintaining accommodative monetary and financial conditions. However, broad and encompassing policy response is important to ensure that we don’t rely overly on individual measures that could be subject to unintended side effects if they are kept in place for too long. For example, if central bank support remains in place for a prolonged period of time, debts accumulate and asset prices are further stimulated, posing risks to financial stability. Instead, a sustainable recovery from the crisis also requires sufficiently productive public and private sector investments. And structural reforms that foster the creation of new firms, while non-viable firms are wound-down in an orderly fashion. Though this can be a painful process for some sectors, the economy has to adjust to a world that might have structurally changed. Monetary policy can maintain appropriate financial conditions to help the economy adjust, but other policy authorities will have to set the adjustment in motion. The EU Recovery Fund has the potential to contribute to this, if it is invested well and accompanied by supply-side reforms. For continued monetary policy support with asset purchases, it is important that the benefits of our interventions – i.e. the contribution to price stability – remain outweighing the potential sideeffects. For central banks the key challenge then is to assess in which circumstances – or states – specific monetary policy instruments are most effective and side effects are most limited. Such considerations are an important element of the ECB strategic review, which will benefit from an evaluation of the monetary policy measures taken in the corona crisis. 1/1 BIS central bankers' speeches | netherlands bank | 2,020 | 10 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Eurofi Financial Forum, Berlin, 10 September 2020. | Klaas Knot: Relaunching growth in Europe together Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Eurofi Financial Forum, Berlin, 10 September 2020. * * * Ladies and gentleman, More than six months after the outbreak of the Covid-19 pandemic, it is clear that the virus has pushed the global economy into deep recession. The European economy has not been spared. What I am particularly concerned about is that the ability to recover from this blow is far from equal across euro area member states. This crisis has thereby reemphasized the challenges to our Economic and Monetary Union. Challenges that are posed by a creeping divergence in productivity growth, competitiveness and per capita income between member states. Although many of you may share my concern, the urgency is not felt by everyone outside this room. Therefore, today I would like to argue why I think growth divergence in the euro area threatens to undermine the benefits of European cooperation. And I will outline how I think we can successfully overcome this challenge. Challenges of the single currency Indeed, the economic benefits of European cooperation are still convincing. Take the European single market. A wide body of research shows it has clear benefits for each and every member state, with small, open economies the Dutch one benefiting most. Also, there are still strong economic arguments in favor of our common currency. A single market like the European market, where there is intensive trade between countries, benefits from the absence of exchange rates. The success of the single market is therefore built on the bedrock of the euro. But we have seen that a single currency also brings disadvantages. Certainly for a group of countries that differ quite a bit from each other economically. Until now the euro has not lived up to its promise of bringing sustainable economic convergence. In fact, we have seen the opposite. As devaluations are no longer possible, countries with lagging productivity growth can only restore competitiveness through wage moderation. But even in competitive countries like Germany and the Netherlands, wage growth is already muted. Structurally undercutting German and Dutch wage growth is therefore easier said than done. You could say that the euro always gives a little boost to the more productive, more competitive economies in the north. To southern economies where productivity growth is generally lower, the euro is a relative burden. That is why the more productive and the less productive economies have a tendency to diverge. If this imbalance persists for too long, it will lead to problems like we saw during the 2011 European debt crisis, when several member states experienced major financial problems and all of us went through a deep recession. The euro crisis taught us that we cannot just abandon struggling euro area member states to their own fate. So, as long as the phenomenon of divergent growth exists, more productive economies will occasionally have to step in to help the less productive ones. But it would be even better to tackle the root cause of this growth divergence. These differences between north and south are not after all a God-given natural phenomenon. It is an uncomfortable observation that in recent years, that some even characterized as euro boom years, many opportunities for economic reform have been missed. 1/3 BIS central bankers' speeches Covid-19 crisis as a challenge to Europe On top of this we now all have a new crisis to contend with, the Covid-19 crisis. What is particularly cruel about this crisis—and I might add hazardous for Europe—is that the most vulnerable economies in the euro area have been hit the hardest. Consequently, their government debt will rise even further. Market concern about their debt levels may force these countries to start cutting their deficits before their economy has been able to recover. Which could further exacerbate economic divergence between euro area member states. In time, this could undermine public support for the euro. To this day, public support for the single currency remains high. But can we take it for granted that it will stay that way? Southern Europe currently reaps relatively little benefit from the euro. And in northern Europe, people often feel they are being called on to bail out their Mediterranean partners. Moreover, within the more prosperous 3 member states the benefits are not always shared evenly. In my own country, for instance, businesses have benefited greatly from the single market and the euro. Due to lagging wage growth and an increasing tax burden, however, the benefits for households are less pronounced. If a large proportion of them start to see “Europe” first and foremost as a private party for businessmen, with scant benefits for their own pockets, then that will undermine support for the European project. I think that is something we should all be worried about. Also, because Europe is about so much more than just the financial benefits. Take the shifting geographic balances of power, the refugee crisis, the climate crisis. You don’t have to be a Europhile to understand that we can tackle these transnational challenges better at European level than at national level. These challenges call for European cooperation within a strong European Union. And this is inextricably linked to strengthening the foundations of our currency union. I am convinced this is perfectly possible. We designed our monetary union ourselves, including its flaws. And that means we can also fix it ourselves, if we want to. Policy for Europe There are three things I believe we need to do for that to happen. The first is to fight this Covid-19 crisis collectively and effectively. This summer, European leaders wasted no time in setting up a European recovery fund. An excellent initiative. What’s very important is that the recovery fund is intended to support public investments that strengthen economic growth potential also in the financially more constrained member states. The recovery fund prioritizes investments in digitalization and a climate-neutral economy. That way, we can kill two birds with one stone: we narrow the gap between those leading the way and those lagging behind, and we invest in the sustainable growth capacity of the euro area. It is also important to note that the fund is temporary. There are no direct transfers between countries. Nor do countries assume responsibility for each other’s debts. While this fund is an important step, it is not enough. And this brings me to the second item on my list: we will also have to coordinate fiscal policy more closely. In recent years, European fiscal rules have been focused on the 3% limit for the budget deficit. As a result, the rules have been strict during bad times, and ineffective during the good times. I therefore think we need to pay more attention to public debt levels. The Maastricht Treaty’s 60% debt limit must regain prominence. It is a recognizable benchmark, and allows member states the room to temporarily increase their debt during economic downturns. However, the pace at which countries are required to return to below this limit, must vary more than it did in the past. The individual economic situation of a country must be taken into account. During economic upswings, countries with higher debt levels should have to make greater efforts to reduce their debt than countries with lower debt levels. In reducing public debt, we should put more emphasis on reforms that enhance economic 2/3 BIS central bankers' speeches growth. Rather than the spending cuts and tax hikes that often initially constrain growth. If austerity is unavoidable, fiscal rules should at least protect public investment. The third point on my European to-do list is to improve coordination in other areas of economic policy. To effectively tackle the divergent competitiveness in the euro area, all member states must play their part. Less productive economies need to implement reforms and investments that increase their productivity and competitiveness. This has obvious benefits for exports, economic growth and employment. And it decreases the productivity gap with more productive economies. These reforms are, however, more likely to succeed if the stronger economies also do their fair share. Large and persistent trade surpluses often hide underlying problems, such as corporate savings retained for tax reasons, or stagnant wage growth. Reforms aimed at increasing households’ purchasing power would therefore not only increase welfare in the more competitive member states, but also make life easier for the more vulnerable ones. But let’s be realistic: such reforms will take time. Even with the right policies in place, it will still take decades for many member states to get to where they need to be. In the coming years, countries with high levels of public debt will unlikely be able to weather another serious downturn without implementing far-reaching budget cuts and tax hikes. These countries then risk falling even further behind. Which would again overshadow our objective of creating a stronger and more coherent monetary union. The best way to deal with this, is something we will have to continue reflecting on. 4 I certainly do not have all the answers. But I do believe that the agenda I have outlined would put us on the way to a stronger currency union. With European governments investing in sustainable growth, both jointly and individually. Through more closely aligned economic policy. More European integration is not a popular message nowadays, I realize that. We could also choose to abstain from further European integration. That’s also an option, certainly. But there is a price to pay for that option. The price involves continued economic divergence between euro area member states, more debt crises, more emergency support and lower levels of prosperity. Would the euro survive such a scenario? All the same, we are living in a different Economic and Monetary Union than we imagined back in the 1990s. With more sharing of risk. And more harmonization of policy. In recent years we have pushed the boundaries of the Treaty. There is no guarantee we will not have to do that again. So it is equally crucial to reaffirm the political mandate. It is up to politicians to state their convictions, and present them to voters in a clear and consequential fashion. If we want to achieve a strong, well-functioning and sustainable Europe that works for all of us, then we must be willing to do what it takes. It requires us to better harmonize our economic policies, and to jointly invest in sustainable growth. Firmly based on member states assuming responsibility for putting their own house in order. With the realization that all member states must do their bit. And with the prospect of creating a better future for us all. Thank you *** 3/3 BIS central bankers' speeches | netherlands bank | 2,020 | 10 |
Speech by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, at the SSM Roundtable, Berlin, 30 September 2020. | Frank Elderson: Covid-19 - A digitalisation boost and the supervisory response Speech by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, at the SSM Roundtable, Berlin, 30 September 2020. * * * As the COVID-19 pandemic unfolded back in March of this year, suddenly hundreds of thousands of financial sector workers were working from home. From board members to secretaries, our homes became our new offices, Skype became our new meeting room. That was a major shock but we adapted quickly. IT systems that once took ages to implement were rolled out in a matter of weeks. Network capacity was stepped up in record time. Also, the trend from cash to digital payments accelerated. Just before the lockdown in mid-March, the Dutch used cash for 3 out of 10 retail payments. Now, they use it for only 2 out of 10 retail payments. That’s a huge drop in cash usage in only a few months’ time. In addition, we have seen a large increase in online payments. What happened back in March could perhaps best be compared with a swimming pool. A year ago, we were merely dipping our toes. COVID-19 pushed us in, and now we are swimming! What is now very clear, is that COVID-19 has accelerated digitalization. Many of these developments are welcome. First and foremost, thanks to our digitalization jump, the financial system largely continued to function as normal. As the world economy went into lockdown, the financial system remained open. This is a remarkable feat. One that bears witness to the operational resilience of the financial sector and to the power and opportunities that digitalization has brought us. Another upside is that customers are getting more used to doing things digitally. This opens up opportunities for banks to introduce new products and to reduce costs. On the risk side, it is notable there were no major operational incidents during the pandemic. At the same time, operational and especially cyber risks have clearly increased. Since COVID-19 we have seen a spike in cyber threats, like ransomware attacks and phishing. And both the risk and possible impact of operational incidents caused by people, failed processes and systems has increased as a result of greater reliance on virtual working arrangements. For example, we have seen that several third party providers suffered ransomware attacks that could have severely affected the financial sector. The big question financial institutions and supervisors need to keep asking themselves, especially in the current environment: is our operational resilience keeping up with the faster pace of digital developments? When it comes to Fintech, I think COVID-19 has also accelerated existing trends there too. The future development of Fintech is a function of technological innovation and changing consumer preferences. COVID-19 did not immediately bring new technology, but it may have moved consumer preferences more towards digital. People kept contact with each other via Zoom and Face Time and Skype. School children all over the world followed online lessons. Online retail went through the roof. From there, it may only be a small step to paying with Whatsapp, or getting a mortgage from Quicken Loans. So COVID-19 may have influenced digitalization in many different ways. If there is anything the COVID-19 pandemic has taught us here, it is that adoption of new technology is non-linear. When technology is already available, sometimes it takes only one event to cause a sudden and decisive shift in consumer preferences. This adds all the more urgency to the big questions already on the table before the pandemic. 1/3 BIS central bankers' speeches How will Fintech impact the business model of traditional banks? What role will bigtech firms play? When the lines between banks and technology firms become more and more blurred, who is responsible for security and financial stability? Do we understand the algorithms that are being applied increasingly in banking? How do new technologies influence cyber and financial crime? Are supervisors sufficiently equipped, in terms of knowledge and staff, to keep up with developments? Where are the holes and obstacles in regulation? What does it mean for the level playing field when regulated and unregulated entities compete on the same markets? How can supervisors themselves use the new technologies to improve supervisory practices? And last but not least, there are social issues involved in digitalization. Not everyone can keep pace with the current tempo of digitization. Digital exclusion of vulnerable groups of consumers, like the elderly or people on a low income, is a serious issue nowadays. This is only a subset of a vast area of questions that are relevant to the stability of the financial system. But I have total confidence this panel of eminent experts will be able to answer these questions shortly. This brings me to the last issue I would like to raise. How should supervisors respond to these changes? There used to be a time when financial supervision was viewed as basically reactive. The idea was that, by nature, supervisors are always at least one step behind the market, and that we should aim to keep the gap as narrow as possible. I think supervisors that still adhere to that view are missing the demands of the new times. If ever, in the current landscape, with fast but fundamentally uncertain changes, supervisors should be forward looking and adaptive. By forward looking I do not mean supervisors like me can predict the future. We can’t. And we are probably worse at it than the industry. But we should stay on top of developments, think in terms of scenarios, and broaden the dialogue from the financial sector to important tech and infrastructure players. And I think this also a good approach when it comes to the development of new regulation, notably the European Commission proposals on the regulation of the use of cloud services by the financial sector, and it digital strategy. And when I say supervisors should be adaptive, what I mean is to acknowledge the fact that existing regulation was often drafted with a different world in mind, that this regulation cannot always be literally applied to the new digital world. Adaptive then means to act from a set of core principles. To apply them in a way that fits the new environment and leaves space for innovation. While continuing to protect customers and financial stability. To give you an example, two months ago we published a discussion paper called ‘General principles for the use of Artificial Intelligence in the financial sector’. To sum it up in one sentence: firms should pay due attention to the soundness, accountability, fairness, ethics, skills and transparency aspects of the applications they develop. We are using this discussion paper, and the comments received, to engage in a dialogue with the Dutch financial sector about the use of AI. Finally, new technology also creates opportunities for supervisors to improve their own effectiveness. In 2018 De Nederlandsche Bank set up a dedicated Supervision Innovation Department to coordinate and accelerate the implementation of its digital strategy. The strategy’s purpose is to adopt a more data-driven approach and deploy technology to support the supervisory process. The ultimate goal is to transform DNB into a ‘smart supervisor’. Also, when it comes to supervision, Covid-19 has increased the awareness of the potential of digitalization. Digital processes are not susceptible to the impact of reduced staff availability during a lockdown. It also increased the broad mindset that digitalization is the new normal and boosted acceptance of working with new digital tools throughout the entire workforce. So to sum up, COVID-19 has stepped up the pace of digital developments. This has given more urgency to the policy questions already on the table. It requires supervisors to be forward looking and adaptive, and to keep up with developments to improve their own supervisory practice. 2/3 BIS central bankers' speeches I’ll stop here and I look forward to hearing your insights during the discussion. 3/3 BIS central bankers' speeches | netherlands bank | 2,020 | 10 |
Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, at the press conference for the autumn 2020 Financial Stability Report, Amsterdam, 13 October 2020. | Introductory remarks by DNB President Klaas Knot at the press conference for the autumn 2020 Financial Stability Report Welcome to the press conference on the Financial Stability Report (FSR). Before we start taking questions, let me briefly walk you through the main elements of our FSR. As in the spring, the main focus of this report is – of course – the impact of the coronavirus crisis on financial stability. This crisis has now been going on for more than six months and the feared second wave of infections is now a reality. Where do we stand in this crisis and how has the financial sector fared so far? Let me say a few things about that. First, uncertainty about the economic impact of this crisis remains as substantial as before. The Dutch economy has so far contracted somewhat less than we feared in the spring. But the resurgence in the number of infections has fuelled renewed uncertainty, as new measures seem necessary, but also because consumers and entrepreneurs are becoming more cautious. A proper assessment of the total economic damage will only be possible once the virus is under control. And it is important to stress once again that the economy and health are not in a zero-sum game. Even without measures the economy will be hit. It is therefore of the essence that everybody contributes to containing the virus. That is in the interest of our health, but also in the interest of the economy. An important – and positive – observation is that the financial system has so far proven resilient. That is of course partly due to the fact that this crisis originated outside the financial system. In that sense it is completely different from the credit crisis, when the problems started in the financial sector itself and spilled over to the economy. We can also see that the reforms undertaken after the credit crisis are bearing fruit. Banks are therefore starting in a much better position, so they are better able to dampen the impact of the coronavirus crisis. Governments, central banks and supervisory authorities have introduced very large-scale measures to curb damage to the economy. It is still too early to evaluate these measures, but the interventions have clearly restored a degree of calm to the financial markets. The measures also directly and indirectly help ensure that the financial sector can continue to fulfil its role effectively. But a large part of the economic impact is yet to manifest itself. When the government measures – such as the NOW scheme and tax holidays – are scaled back and bank moratoria expire, bankruptcies will rise. So, we will have to be prepared for that. 1) How is the financial sector faring more than six months into the coronavirus crisis? Financial conditions have greatly improved since the spring due to the massive central bank interventions, and market sentiment has turned around as a result. The economic outlook is extremely uncertain, but despite that investors seem broadly optimistic. They seem to be counting on continued support from central banks and governments. The sentiment is therefore somewhat artificial and new corrections are looming. On top of that, there are uncertainties surrounding Brexit and the US presidential elections. With regard to banks I would briefly like to recall the pandemic stress test that we conducted in the spring. This stress test showed that banks could continue to lend even in considerably adverse economic conditions. Only in a so-termed perfect storm scenario would they be forced to cut back their lending. Despite the resurgence in the number of infections, the economic impact so far has clearly been lower than in the two severe scenarios in the stress test. Banks still remain sufficiently shock-resistant and have been able to keep lending. But this is a period of calm before the storm for banks. Relatively few firms and households have encountered financial difficulties so far, but this will doubtless change. Particularly if the support measures are wound down. Banks are well aware of this. It is why they have set aside substantial provisions for possible loan defaults in the future. Insurers are not being affected so directly by the coronavirus crisis, but they have been under heavy pressure from persistently low interest rates for a long time. This is especially impacting life and funeral insurers. Pension funds saw their funding ratios hit hard in the spring, after which a partial recovery set in. Their financial position nevertheless remains vulnerable. A positive point is that the pension agreement concluded during the summer meant significant advances were made, towards a more future-proof pension system. 2) What does all this mean for policy? How can we limit the damage to the economy and the financial sector, particularly with the virus resurging and the pandemic set to continue? The key challenge is still to prevent the economic crisis from sparking a financial crisis. That really would exacerbate the problems and push the economy into a negative spiral. All our efforts are therefore focused on preventing that. The very extensive support measures introduced by governments have so far helped the financial sector to dampen the shock rather than reinforce it. Particularly now that a second wave has arrived, we need to be especially cautious about a premature scaling back of these crisis measures. That could inflict more severe damage to the economy and pose larger risks to the financial sector. The cost of winding measures down too early as yet outweigh the potential cost of leaving them in place for too long. It is important that the support measures are in due course rolled back in a gradual and predictable way to prevent cliff-edge effects. In a severe shock such as this, which originated entirely outside the sector, it is only logical for the government to absorb a large part of the shock. The Netherlands can also afford a temporarily higher public debt. The fact that the government has now laid down its support measures for a longer period of time will help reduce uncertainty for firms and households. The Netherlands of course also depends on what happens in other countries. Our economy and financial sector are closely interconnected with those of other European countries. The creation of a European recovery fund during the summer was therefore a positive move. We must prevent this crisis from leading to even greater economic growth imbalances in Europe. As for DNB, we have given banks additional leeway to continue lending and absorb any losses by adjusting the buffer requirements for the major banks. In view of the current uncertainty we will be continuing these crisis measures. At any rate, the floor for the risk weighting of mortgage loans and the countercyclical capital buffer will not come into force before the end of 2021. In summary, we are still in a historically deep economic crisis. Fortunately, this has not so far sparked a financial crisis. But with the pandemic flaring up, economic uncertainty is yet again increasing. The main challenge in this next phase is therefore to limit the damage to the economy and prevent the crisis from spreading to the financial sector. This concludes my introductory statement. I would be happy to answer any questions you may have. | netherlands bank | 2,020 | 10 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the online IIF Annual Membership Meeting, 14 October 2020. | “COVID-19: how to contain the impact on the financial system” Speech by governor Knot at the online IIF Annual Membership Meeting 14 October, 2020 In his novel The Sun Also Rises, Ernest Hemingway describes a conversation between two men, one of whom recently went bankrupt. “How did you go bankrupt?” Bill asked. “Two ways, ” Mike said. “Gradually and then suddenly.” End of quotation. This neatly sums up the risk we face at this stage of the economic crisis. Until now, governments and central banks around the globe have been able to mitigate the economic fallout from the COVID-19 pandemic. But the health crisis persists. Many countries are now experiencing a second wave of infections. For the economy, this means recovery now seems further away than we had hoped for. And the economic impact is deepening. Many firms that so far have managed to keep their heads above water, may as yet go under. The banking sector is likely to feel the consequences of that in the near future. So as the economic slump continues, the question becomes more and more pressing: How do we, as governments, central banks, and financial institutions, how do we prevent the economic crisis from spilling over into a financial crisis? That is what I would like to focus on today. To start on a positive note, as we all know, this time the shock did not originate in the financial system. It comes purely from the outside. That is a key difference from the global financial crisis of 2008. Also, banks are much better capitalized and have more liquidity than 12 years ago. As a result, the banking sector has done relatively well. It has been able to absorb much of the shock and keep credit flowing. So far, banks have been part of the solution rather than part of the problem. I think it’s fair to say this is largely thanks to the post-crisis regulatory reforms. Over the past 10 years we have worked to strengthen buffers in the banking sector. We now see the rewards of our efforts. Yet, I remain cautious. First, let’s not forget that back in March some market segments were under considerable stress. There was a search for liquidity in short-term funding markets, and money market funds in particular came under pressure. Central banks had to intervene to make sure markets continued to function and provide credit. Whereas 12 years ago we had to bail out the banks, this time, we have had to backstop certain markets. Secondly, COVID infection rates are on the rise again in many countries. Restrictive measures have been re-introduced, and uncertainty is increasing. This is bad news for the economy. The fiscal and monetary stimulus packages have until now cushioned part of the blow. But as the economic slump drags on, firms and households will start feeling the impact more and more. In such an environment, insolvency rates will increase. That’s simply inevitable. That means that banks, while having initially done well, are going to take hits to their loan books. Unfortunately, this happens while the banking sector in at least some countries in Europe is still struggling with NPLs from the previous crisis. How big the hit will be is still very uncertain. Yet it would be wise for both policymakers and banks to brace for impact. If this is the case, what should policymakers do now? In the short term, I think it’s important governments and central banks continue to support the real economy as long as necessary. It is inevitable and only right that this support will be gradually halted. But now is not the time to phase out the fiscal and monetary stimulus. Where possible, fiscal policy should move from general support to more targeted investment, aimed at supporting the transition to a carbon-neutral economy and digitization. Next, supervisors should continue to give room to the banks to use their capital buffers. Capital buffers are the airbags of the financial system and we should use them in a crisis. That is after all what they are there for. Of course, the dilemma is: how much? Here we have to weigh the need to cushion the current blow against the need to also be ready for future headwinds. What can the financial sector do? Focusing here on banking for a moment, I would say: do what you normally do. Ensure credit keeps flowing to the real economy. Make use of the available headroom to do so. Make sure capitalization remains at prudent levels. And very important: keep a keen eye to risks and asset quality. Now this may sound like the basics of banking. But I recognize it is hard to stick to the basics in these increasingly challenging circumstances. As more firms face mounting financial troubles, banks will need to re-focus on the long-term viability of their corporate customers. Sometimes debt restructuring may be part of the solution. Government support and low interest rates may provide a helping environment here. We will also have to take a closer look at financial stability risks in the non-bank financial sector and what it implies for regulation and supervision. Events in March clearly indicate this is where vulnerabilities in the financial system have piled up over the past years. That shouldn’t surprise us. The financial reform agenda after 2008 was heavily focused on banks. In the financial system there is what I call the ‘waterbed effect’. Pressing down on one end of the financial system will cause risks to pop up elsewhere. And, indeed, since 2008 non-bank financial intermediation, or NBFI, has grown much faster than bank intermediation. It now accounts for about half of all financial assets worldwide. So, whereas in the aftermath of the previous crisis the emphasis was very much on the banks, we now have some catching up to do when it comes to financial markets. A key question here is how to appropriately reflect financial stability considerations in regulating market-based financial intermediation. The answer to this question needs to take into account the specific nature and diversity of NBFI. This includes differences in the sources and nature of liquidity risks. It also includes the close interconnectedness in the NBFI sector. Why did certain types of money market funds experience a run in March? What role did the trading strategies of hedge funds play in the dislocations in US Treasury markets? These are just two current examples of the kind of questions that we will have to answer. So we need to better understand how these markets function and what the systemic risks are. And this is actually what we are doing now in the Financial Stability Board. We have recently launched an initiative to examine what happened, and to draw lessons from the events in March this year. This includes implications for particular market segments but also for the desired overall level of resilience in non-bank financial intermediation. Relatedly, we are examining interconnections within the nonbank sector and with banks. We want to better understand the propagation mechanisms that played such a big role in the ‘dash for cash’ episode. Taking advantage of the FSB’s broad membership, all relevant types of authorities take part in this work, including the central banks that had to intervene, and the market regulators overseeing these markets. I think the general conclusion of the FSB-review could be to strengthen risk surveillance in the nonbank sector and take steps to enhance the sector’s resilience. This includes reviewing the effectiveness and adequacy of the instruments that are already available. To wrap up, in the near future banks are likely to start feeling the impact of months of economic disruption. Also, events in March demonstrated there are financial stability issues in non-bank financial intermediation. In the short term, fiscal and monetary authorities, supervisors, and banks should continue to do what they have done so far: provide the necessary stimulus, use buffers and provide credit, while keeping prudent levels of capital to be ready for future headwinds. In the medium term, we have to look more closely at regulation of non-bank financial institutions. This will allow us get a firmer grip on the financial stability risks there. | netherlands bank | 2,020 | 10 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Euro50 Group Videoconference, 15 October 2020. | “The ECB’s strategy review against the background of the Covid-19 crisis” Speech by governor Knot at the Euro50 Group Videoconference 15 October, 2020 (I) Setting the stage In my remarks, I want to take a look at current efforts by central banks to review their monetary strategies. I will do this from a euro area perspective. To set the stage, let me describe how the macroeconomic environment in which central banks operate has changed markedly since 2003, when the ECB last reviewed its monetary strategy. This was the motivation for the ongoing review. The main changes include: 1. The fall in the natural real rate of interest, often called r-star. While notoriously uncertain and dependent on modelling assumptions, estimates of the equilibrium interest rate have declined visibly since the early 2000s (see Chart 1). 2. The significant decline of different measures of inflation over the past decade, and particularly since 2014, associated with lower trend inflation and higher inflation persistence (see Charts 2-3). 3. The broad increase in uncertainty, including on: • the nature of shocks hitting the economy; • the effectiveness and transmission of our policy tools; • how agents form expectations of the future and whether their long-term inflation expectations are well-anchored to the central bank’s inflation aim; and more. The decline in inflation, which is the main variable of interest for monetary authorities, is particularly noteworthy. During the Great Recession, we used to talk about the “missing disinflation puzzle”, while between 2014 and 2019 we discussed at length the “missing inflation puzzle”. A flatter Philips curve might be one explanation for both. But the policy debate and in academic research have shown that the decline in inflation can also been explained by other factors, or other narratives. One such plausible narrative for low inflation is a Phillips curve that is alive combined with a fall in trend inflation. This downward trend arguably reflects structural but not necessarily secular factors in the global economy – most notably globalization, digitalization and demographics. Although there is no consensus on their relative importance, it is clear that central banks have only incomplete control over the disinflationary impact of these factors. (II) The Covid-19 shock It is in this evolving environment, in which the ECB strategy review has been ongoing, that Covid-19 hit like a meteorite. The Covid-19 shock is an unprecedented, truly exogenous, global shock with markedly different sectoral effects. In 2020Q2, the shock has caused a historic collapse in output. Moreover, the shock has magnified the already heightened uncertainty and has prompted behavioral changes – like the substantial increase in households’ propensity to save – which if persistent, are likely to have lasting macroeconomic consequences. The Covid-19 shock has both supply and demand elements, which called for different types of policy responses. As far as monetary policy is concerned, the demand character of the shock required a strong and fast response from monetary authorities to support the economy. (III) Instruments With inflation already low for some time before the Covid-19 crisis hit – something the ECB had been uneasy about – monetary policy has already been stretched. In the euro area, as in many other economies, policy rates have been stuck close their effective lower bound. And central banks have come to play a large role in financial markets and in financial intermediation. This has implications for the monetary policy space that we enjoy in the face of this unprecedented shock. It also has implications for the functioning of financial markets, most notably safe assets and bond pricing. A theme of the ECB’s strategy evaluation that has therefore become even more important is to what extent unconventional monetary policies create policy space and thus help to overcome the effective lower bound. To me, the answer is state dependent. For instance, there is ample evidence that asset purchases are more effective at times when market frictions or stress are the highest. As the Covid-19 crisis unfolded, in the euro area this was most visible in the fragmentation of bond markets. It is mainly for this reason that the extension of our Asset Purchase Programme and the Pandemic Emergency Purchase Programme were the most logical monetary policy instruments in the first month of the Corona crisis. The flexibility embedded in PEPP, moreover, allowed it to fulfill its dual purpose, namely to counter the serious risks to (i) the monetary policy transmission mechanism (see Chart 4) and (ii) the outlook for the euro area posed by the outbreak and escalating diffusion of the coronavirus, COVID-19. In parallel, ample liquidity support to banks in the form of TLTROs/PLTROs has been important to ensure a stable credit flow to the real economy (see Chart 5) But there are clear limits to what monetary policy can achieve in the face of a pandemic that may stretch out. (IV) The policy mix This brings me to a central question for policymakers at the current juncture: what is the most appropriate policy mix in the face of these old and new shocks hitting our economies? My main message is twofold: First, it is fiscal policy that has to be in the lead in mitigating the macro-economic consequences of this prolonged public health emergency. Efforts that monetary policy can support by keeping financing costs low for all borrowers Second, the macro-economic implications of the unprecedented corona shock and continuing elevated levels of uncertainty require coordination of efforts from all policy areas. Most importantly in this context, between monetary and fiscal authorities. Unlike the period of the European sovereign debt crisis, the current constellation of policies has been characterized by a massive easing of both fiscal and monetary policy. Looking forward, however, I see two possible scenarios that we may wish to avoid. The first scenario is one in which, in the aftermath of the public health crisis, fiscal authorities withdraw their support for the economy too early, in the aftermath of the public health crisis. This would entail a further stretching of monetary policy to its borders and beyond, as inflation may continue to remain below target. The second scenario is the one depicted recently by Charles Goodhart, in which the downward trend of inflation is reversed on the back of a reversal of demographic and globalization trends, rising labor bargaining power, and rising interest rates. He argues that the Covid-19 pandemic may accelerate this reversal. If inflation indeed were to rise sharply and debt were to be stuck at high levels, monetary policy would be caught between a rock and a hard place. This could end up a test for safeguarding monetary dominance and avoiding a regime of fiscal dominance. The Next Generation EU Covid-19 recovery package could play an important role in steering away from these two scenarios. By conditioning the funds on growth-enhancing structural reforms, the package may further reinforce efforts to have fiscal and monetary policy optimally interact; a crucial ingredient to avoid the two scenarios and to return towards a good post-corona equilibrium. Only then will we be able to effectively stabilize the economy, prevent long-term (hysteresis) effects and pave the road for a sustained recovery. And with this, let me conclude. | netherlands bank | 2,020 | 10 |
Speech by Mr Klaas Knot, President of the Netherlands Bank (DNB), at the OMFIF-DNB Conference "Developing European Capital Markets", online, 3 November 2020. | Error! Unknown document property name. “On the right track: why is the Capital Markets Union important and how do we get there” Speech by governor Knot at the OMFIF-DNB Conference ‘Developing European Capital Markets’ 3 November, 2020 Error! Unknown document property name. Let me start by thanking you all for being here today. If you travel by train from the city of Bordeaux southward to Spain, at the border you will have a slightly strange experience. Since the rail gauges in France and Spain are of a different width, the rail bogies, that’s basically the wheels of the train, have to be replaced. A very heavy machine lifts the train up, the bogies are rolled away and replaced by others. It takes about one hour before the traveler can resume his or her journey. This rather remarkable example of systems that do not fit together, and that reminds one of the nineteenth century, is not uncommon in European capital markets. This becomes clear if you compare it with the United States. Consider a US investor located in Iowa who wants to invest in a firm located in Florida. Information on the firms finances can be readily accessed via the Securities and Exchange Commission, while securities and insolvency law are of course similar across states. Now consider the same process for a Belgian investor aiming to invest in Portugal. Firm information is scattered across business registries, while the investor has to accustom itself to various local rules. This goes from small discrepancies, such as rules on shareholder disclosure, to large differences, such as insolvency laws. Whereas large areas of the European economy have become more and more integrated, capital markets in Europe are still fragmented to a large degree. This results in real costs. The Capital Markets Union has clearly moved on from being a ‘nice to have’ to a ‘need to have’. Why is a unified European capital market important and how do we get there? That is the topic of today. I think the importance of this topic is already reflected in the quality of speakers on the agenda for today. So allow me to thank all the speakers for being here, and I look forward to our exchange of insights and ideas. Being the first speaker, my aim is to set the stage for a fruitful discussion in the later sessions. In my remarks today I will first briefly share my view on why the Capital Markets Union is so important. As the potential benefits of the CMU are numerous, I will stick to why the CMU is important for us as a central bank. Second, I will put forward some guiding principles on how I believe further progress can be made. Importance of CMU For us as a central bank, the Capital Markets Union is key to a more resilient European economy. Well developed and integrated capital markets lead to more risks being shared privately, reduces systemic risk and stimulates diversification of the funding mix of corporates. This will also help our economy to recover from the Covid-19 shock. The CMU is therefore highly relevant to our central bank mandate of ensuring economic and financial stability. So why are these goals important? Well to start off, we know already from the financial and sovereign debt crisis that the European economy proved fragile. More specifically, it lacked proper risk-sharing mechanisms. Moreover, an overreliance on banks in the financial system led to additional risks. Risks were mostly concentrated within countries, on bank balance sheets. Ultimately, bank losses had to be borne by the public, while new lending was constrained for years. You could say that Europe lacked a ‘spare tire’ to raise new financing for firms and speed up the economic recovery. In response we have made various changes to the institutional framework to support resilience of the financial system and foster financial integration. We have reduced risks on bank balance sheets through uniform European supervision and increased capital requirements. Moreover, the resolution mechanism offers a backstop mechanism in case a bank runs into difficulties. Error! Unknown document property name. Less progress was made, however, on the sharing of risks, in particular through private channels. European financing remains too one-sided: firms and households depend too much on banks, and the home bias of investors is persistent. These forms of fragmentation and concentration make the economy vulnerable to shocks and increases systemic risk. So how did our financial system contribute to coping with the current Covid-19 shock? Partially as a result of past regulatory efforts, the banking sector has done relatively well so far. It helps that this shock did not originate from the financial sector itself, but is strictly exogenous. Supervisors have also helped to prevent financial amplification by giving room to banks to use their capital buffers. Central banks have also intervened on a massive scale to ensure financial markets continued to function and provide credit to the real economy. In particular, central banks have supplied banks with additional liquidity to incentivize them to lend to the real economy. A cruel property of this crisis is that the most vulnerable economies have also been hit the hardest. Governments have therefore taken an important step towards public risk-sharing by setting up the Recovery Fund. What I find crucial in the Recovery Fund is that it supports public investments that strengthen economic growth potential also in the financially more constrained states. The Recovery Fund helps to absorb the current shock with the aim of reducing future fragilities as well. By doing so, we hit two birds with one stone. That being said, paving the way for a successful recovery will also require private investments. And given the bank-based nature of the European economy, it makes sense that most measures taken in response to the crisis work through banks. However, the irony is of course that this may increase the focus on banks in our financial system in the longer term. And this is not without risk. Because as the crisis drags on, banks are going to take hits to their loan books. This might make it more difficult for them to keep credit flowing. Therefore we need additional funding mechanisms to support the economic recovery. This is also a key lesson from earlier crises. Finally, even with public risk sharing through the Recovery Fund in place, the need for complementary risk sharing through private markets remains high. It is important to note the Recovery Fund is temporary. And I think this makes sense. A Europe that is kept together through large transfers of public funds is vulnerable from a political perspective. By developing private risk-sharing capacity, risks are borne by parties that have agreed to carry risk, and are shared by a larger number. This should lower the effect of a shock. It would also put less strain on the banking sector, as well as on monetary and fiscal policy. As you undoubtedly know, in countries with well-integrated capital markets, like for example the US, private risk sharing absorbs more of a shock than public risk sharing mechanisms. CMU All in all, the potential benefits of capital markets are very significant. And that’s why we need a wellfunctioning Capital Markets Union. So, in terms of progress with CMU, where are we today? The European Commission has launched several proposals over the past five years, and many of these initiatives are now implemented. They are clearly a step in the right direction. We have harmonized rules in various areas of financial markets, for instance on investment funds and prospectus regulation. However, it is also clear that progress on the CMU has been rather slow. Banks remain central to the European financial sector, while home bias and wide differences in corporate funding costs remain persistent. So why is realizing the CMU so challenging? First of all it is not always clear what barriers stand in the way of market development and integration. This is because capital markets are much more heterogeneous than banks. So to push the CMU ahead, you likely need a mosaic of small but interlocking measures. The NextCMU working group, followed by the High-Level Forum, have already laid important groundwork on identifying such measures. Another challenge is that competing national interests make realizing the CMU difficult. Even though all member states acknowledge the benefits of the CMU, specific measures often cannot muster enough Error! Unknown document property name. political support. This is to some extent understandable, as many of the regulations relevant for CMU have been put in place to serve other public objectives as well. I think insolvency law is a case in point. I am happy to see the European Commission has recently launched a new action plan to push ahead with Capital Markets Union. Although I am not directly involved in further developing these proposals, allow me to share three observations on what I think is necessary: First, we need to prioritize. The list of potential benefits of the CMU is long. As a consequence, the goals that member states pursue through the CMU can diverge widely. In the new action plan, the European Commission has already brought more focus in the debate by separating initiatives on for instance digitalization. The next step would be to further flesh out the measures that should be prioritized in order to bring the CMU ahead. I am optimistic that the Commission together with the member states will succeed in doing this in the next months. Second, we need to focus on further harmonization of market practices, rules and regulations. Divergence between national frameworks in the EU is often the most cited barrier to cross-border investments. For instance, the disparity between rules and practices regarding insolvency frameworks remains sizable between Member States. The speed of resolving insolvency procedures can vary within the EU between five months and more than 3 years. Different rules lead to uncertainty on the relevant rights and obligations. I admit that harmonization of these frameworks is sensitive and complex. Furthermore, as I mentioned earlier, national insolvency frameworks are often designed with other public goals in mind as well. Yet if we really want a CMU, we need to take action in these fields. This could be done by focusing on harmonization or minimum standards of specific elements, for instance the length of procedures. Third, we must value all steps in the right direction, even the small ones. The functioning of capital markets is complex, and different types of players are involved. It is likely that there is not one single initiative that will make the difference. Rather, obstacles need to disappear gradually, similar to the Single Market. To give just one example: we have to increase the availability and comparability of firm information, for instance through a single access point. Information is now frequently scattered between national registries, and this is therefore a crucial step towards a more integrated market. However, this requires intermediate steps to be taken first, for instance the harmonization of definitions. To finish up The new CMU action plan shows ambition and the scope of proposals is right. Taken together, these proposals mark an important step in further developing and integrating our capital markets. I am also pleased to note that many of the attendees here today have spoken in favor of the need for further steps in realizing the CMU. The momentum definitely seems to be there. At the same time, various proposals remain sensitive, complex and can be difficult to realize. We thus need Member States to be ambitious and commit to reforms. We also need supervisors and industry representatives to keep thinking along on how we can make capital markets function better. In Europe we have seen time and time again that we can converge in pursuit of a common goal if we are really committed. My hope would be that the CMU will be the next exposition of that quality. And that in the future the rail tracks of our capital markets will seamlessly fit together. Let me stop here and thank you all again for being here today. I look forward to a fruitful exchange of insights and ideas. | netherlands bank | 2,020 | 11 |
Opening statement by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, to the Economic and Monetary Affairs Committee of the European Parliament (virtual), 9 November 2020. | Frank Elderson: The challenges facing the ECB and Europe Opening statement by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, to the Economic and Monetary Affairs Committee of the European Parliament (virtual), 9 November 2020. * * * In his opening statement in European Parliament at the formal hearing for the position of member of the Executive Board of the ECB, Frank Elderson spoke about the challenges facing the ECB and Europe, notably Covid-19 and the climate crisis, and about gender diversity. *** Dear Madame Chair, honourable members of the European Parliament, It is an honour for me to speak to you today. Unfortunately, the Covid-19 restrictions make it impossible to come to the parliament physically. As soon as circumstances allow, it would be my privilege to meet you in person. This hearing takes place at a time of great challenge for Europe. Covid has caused deep human suffering throughout our communities, and has taken a severe toll on our economies. The climate crisis remains as daunting and urgent as ever. These challenges present us, as policymakers, with a solemn responsibility. Both the European Parliament and the European Central Bank have a key role to play in steering Europe through the current crises, and in making it better and stronger for the future. Being fully conscious of the importance of this moment, I feel especially humbled and honoured to have been selected as a candidate for member of the Executive Board of the ECB. I welcome this hearing as a key step in the appointment process. Central bankers are independent and unelected. Yet their decisions have an enormous impact on the lives of citizens. For their legitimacy, it is essential that central banks operate within their legal mandates, listen to concerns of the public, and account for their decisions to the people and to you, their representatives. In my short remarks, I will outline my experience before discussing my views on the challenges facing the ECB and Europe in the near and medium term. Finally, I will turn to gender diversity. Qualifications I have been a central banker for most of my career. I have been a member of the Governing Board of the Dutch central bank for more than nine years. At European level, I am a member of the ECB Supervisory Board and I served as one of the first members of the Single Resolution Board. At international level, I am a member of the Basel Committee on Banking Supervision, and I chair the Central Banks and Supervisors Network for Greening the Financial System, the NGFS. In these roles I have learned how bringing different people and voices together leads to better decision making and more effective policies. As a lawyer, I myself have often brought a different perspective to decision-making, highlighting the need for sound legal bases and the importance of adhering to the principle of proportionality. I have also learned that good leadership is to keep a keen eye on developments that at first do not appear relevant to a central bank, but which on closer scrutiny may have a big impact on its objectives. 1/3 BIS central bankers' speeches I began my remarks with the challenges Europe faces. Let me now briefly set out my views on how the ECB can help overcome them. Covid-19 The foremost among these is Covid. The ECB has played a crucial role in cushioning the economic blow from the Covid-19 crisis by easing financing conditions for firms, households and governments. The ECB has shown a steadfast commitment to its mandate to maintain price stability, as laid down in the Treaty. Notably, it acknowledged that inflation that is too low for an extended period of time can be as problematic as inflation that is too high. Going forward, the ECB should continue to do whatever it can within its mandate as long as necessary to mitigate the economic impact of the pandemic. As member of the Executive Board of the ECB, I would adhere to its course of unfaltering commitment to its mandate, and agility under changing circumstances. I welcome that in these challenging times the ECB is conducting its strategy review. Ensuring that the ECB continues to fulfil its mandate requires not only discussing its definition of price stability. It also requires assessing whether the instruments for achieving price stability are still appropriate. However, monetary policy does not operate in isolation. The effectiveness of the ECB’s policies is greatly supported by policies in the supervisory and fiscal domains. First, a robust financial sector is key to supporting the economy during the recovery. The SSM has taken important supervisory and capital relief measures to allow banks to keep financing the economy. What we need to do now, despite its challenges, is to complete the Banking Union, including a European deposit insurance scheme. Also, large investments needed for the recovery from the Covid- 19 crisis underline the importance of finally creating a genuine Capital Markets Union. Second, the current crisis calls for a continued strong role for fiscal policy. With its strong element of solidarity, Next Generation EU is a game-changer. It will provide much-needed support and promote new sources of growth especially for those suffering most from the pandemic. In doing so, it will not only benefit each Member State but also the European Union as a whole. Digitalization and climate change This leads me to two developments that are at the top of the EU’s agenda, including yours. Developments that will be of major relevance to Europe and the ECB for the coming years: digitalization and climate change. The pandemic is accelerating the digital transformation in a way that is likely to reshape our economies and societies. Technological innovation in finance is a good thing. It will enable cheaper, faster and more secure services, increase competition and financial inclusion, and thereby enhance peoples’ welfare. But it raises fundamental questions, including about digital sovereignty, the role of Big Techs, and about the future development of a digital euro. Central banks should stay on top of developments, think long-term, and broaden the dialogue, for example with privacy regulators, infrastructure players and the wider public. The Covid-19 crisis also provides an impetus to the transition toward a carbon-neutral economy. The ECB has a responsibility to contribute – within its mandate – to addressing the longer-term challenges our economies are facing, in particular climate change. 2/3 BIS central bankers' speeches This requires action today. In this regard, I commend this Parliament on its work on the EU Taxonomy. The taxonomy is an important step in the process of greening the financial sector. It provides a reliable basis for follow-up policy actions, including greater clarity on what are the most harmful activities. When it comes to monetary policy, the ECB should explore how it could design – within its mandate – its instruments to adequately manage climate related risks and to contribute to unlocking investments that support the green transition. In its supervisory role the ECB must make sure that banks adequately manage climate-related risks. Diversity And now I would like to say something on diversity, and gender diversity in particular. I know many of you would have preferred to have a hearing with both a female and a male candidate. I know of your concerns regarding gender diversity. I share them. The European Union is founded on equal rights and on the very value of diversity, as expressed in its motto: in varietate concordia. Diversity is our treasure, and it is time we unleash its full potential. Within the Dutch central bank I have actively promoted diversity, including gender diversity. And we have shown that positive change is perfectly possible. The aim is and has to be gender equality. As member of the Executive Board I would strongly advocate that the ECB, and all National Central Banks and all National Competent Authorities, commit to that very aim, and achieve it. Beyond bringing our own house in order, we can and should require more from financial institutions to make their boards and staff composition more diverse. Not just as a box ticking exercise, but to achieve real change. The Capital Requirements Directive you have colegislated gives us supervisors a sound legal basis to do just that. If confirmed as member of the Executive Board, I will do my utmost to make this a greater priority. The challenges are many. But we can meet them, working together in mutual trust and in good cooperation. If confirmed, it is in this spirit that I would seek to contribute to the ECB’s important work and work with you, the European Parliament, for the benefit of the euro area and the prosperity of its citizens. I thank you for your attention and look forward to this hearing. 3/3 BIS central bankers' speeches | netherlands bank | 2,020 | 11 |
Speech by Mr Frank Elderson, Executive Director of Supervision of the Netherlands Bank, One Planet Summit, Paris, 12 December 2020. | “Climate Finance: Towards carbon neutrality 2050” Speech Frank Elderson at the One Planet Summit Saturday December 12, 2020 Merci monsieur le president for the invitation to speak today at the 5th anniversary of the Paris Agreement. Dear honourable guests, Governor Villeroy spoke about what the NGFS has achieved in the three years since its inception. Let me now say a few words on the way ahead. Because, as you know, our job is far from finished. Financial firms wield leverage over their clients and hence over the real economy. Central banks and supervisors on their turn wield enormous leverage over their respective financial sectors. Therefore, central banks and supervisors have double leverage. And the NGFS adds a triple layer of leverage: by pushing our now almost 80 member central banks and supervisors around the world into a Paris Agreement compatible exercise of their mandates. With great leverage comes great power and with great power comes great responsibility. We will continue to push as hard as we can on our triple lever. In the coming years, the NGFS will continue to provide a platform for its members to exchange experiences and best practices. Constantly encouraging, supporting and propelling those behind to catch up with those at the forefront. We will focus on gaining a deeper understanding of how climate change and biodiversity loss affect our own balance sheets and the balance sheets of the financial institutions we supervise. This will boost the quality of the management of the financial risks caused by climate change and biodiversity loss. I say: climate change and biodiversity loss because it is high time to go beyond climate: the world cannot afford to focus on climate change for the next decades and then turn its attention to biodiversity loss. By then there will be no biodiversity left to save. And the financial risks caused by such loss will have manifested themselves much earlier. So what do we need? Better and comparable data are imperative, as well as the further improvement of future-looking risk management tools such as stress testing based on climate and environmental scenario’s. We will also continue to practice what we preach by showing how Central Banks’ reserves can be invested in more sustainable and responsible ways and we are looking further into how climate risks affect our monetary policy. Yet we cannot do this alone. Governments need to further develop taxonomies and clear transition paths, so that companies, households and financial firms know what to expect and can make better investment plans. Standard-setters must set global reporting frameworks. Financial and non-financial firms must improve their disclosures. Crucially, CO2 emissions must be priced in such a way as to enforce a Paris compatible transition to a net-zero economy. Five years ago, governments from nearly 200 countries made a promise. To keep the earth safe and inhabitable for future generations. Today, we must face the fact that we are running behind schedule to deliver on that promise. The tragedy is that the tragedy is no longer at the horizon. The tragedy is now. The famine, the floods, the fires and the refugees are now. COVID-19, however dreadful in itself, provides us with a unique opportunity to regain the lost ground in the battle against climate change and biodiversity loss. Governments worldwide are investing trillions of euro to help our economies recover from the COVID-19 crisis. Let those trillions be green trillions. The task before us is big and complex. But we have the money, we have the technology, it is clear what we have to do. The only thing we further need is the will and determination to do it now. Nous avons perdu une bataille, mais nous n’avons pas perdu la guerre! Il faut la gagner! | netherlands bank | 2,020 | 12 |
Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank (DNB), at the UBS European Conference, online, 10 November, 2020. | Error! Unknown document property name. “Monetary policy in the face of the Corona pandemic.” Introductory remarks by Klaas Knot at a panel at the UBS European Conference, 10 November, 2020 Error! Unknown document property name. The changing environment • We are currently living through the second global crisis – and the third major crisis in Europe – in less than a generation. And again, uncertainty is huge. • The Corona crisis hit at a time when important developments have been changing the macroeconomic, financial and policy landscape. o In the global economy, we have witnessed a falling natural rate of interest, lower trend inflation, and further globalization and technological progress. o In the financial area we have seen high debt levels and leverage, a large role of central banks in financial intermediation, and a high demand for safe assets. o On the policy front, the past years were marked by non-standard monetary policy, macroprudential policy, and active fiscal policy. The unprecedented challenge • In the first wave of the Corona crisis, the main economic consequence was a sharp fall in output together with the threat of a major liquidity crunch and financial amplification. Consumer attitudes and spending behavior changed drastically. • We have been able to avert a full-fledged crisis by a decisive fiscal, monetary and regulatory response. • o The fiscal support was unprecedented in the postwar era, as documented by the IMF in its Fiscal Monitor. It has dwarfed the stimulus provided in the wake of the Global Financial Crisis (GFC), and helped in keeping firms solvent and workers protected. It is important to note that in the European Union, the national responses to the Corona crisis are strongly reinforced by the landmark Next Generation EU Recovery Plan. o With very accommodative monetary policy we were able to prevent a major liquidity crunch and financial amplification. Monetary policy entered the Corona crisis already being stretched in many advanced economies. Policy rates were already close to or stuck at the effective lower bound and central banks had taken over a large role in financial markets and financial intermediation. o This was particularly the case in the euro area. The ECB’s response to the pandemic had a dual aim. First and foremost, protecting the monetary policy transmission mechanism by containing spreads and risk premia. And second, mitigating the economic impact for the euro area of the outbreak and escalating diffusion of the coronavirus. The Pandemic Emergency Purchase Program has therefore been the most obvious response to the crisis so far, complemented by TLTROs and PLTROs to ensure bank credit flow. Last but certainly not least, regulatory constraints were also temporarily eased to allow banks to provide additional funding to firms and households that were in need. The second wave • The events of the past weeks, however, show that the virus remains among us, and that in spite of all efforts, a second wave has not been – and potential subsequent waves may not be – avoided. This second wave is hitting economies that have not yet fully recovered from the earlier blow. And there are highly indebted sectors where firms are increasingly fragile. • Going forward, economic activity will likely be subject to a bumpy trajectory, until the availability of a vaccine paves the way for the recovery in output and inflation to take hold convincingly. Yesterday’s news confirms that we can be hopeful that there will indeed be an end to this pandemic emergency, as medical solutions are being developed succesfully. Error! Unknown document property name. • At the same time, uncertainty will remain with respect to the widespread availability and deployment of a vaccine, which implies that the spectre of potential future containment measures may weigh onto economic activity into 2021. The outlook will be shaped by different forces, which may pull it in different directions. • On the one hand, activity has rebounded much more strongly in Q3 than expected. This confirms that idle resources can resume economic activity much faster when no longer constrained by cointainment measures, which will support the medium-term inflation outlook. Moreover, households and firms seem to adapt better to the pandemic and the containment measures, which arguably makes activity more resilient. • On the other hand, as the pandemic is drawn out into 2021, the financial situation of firms will become more vulnerable. This raises the risks of a financial amplification of the Corona shock, with liquidity problems morphing into solvency problems that affect bank resilience. Such mechanisms were very manifest during the GFC a decade ago; any reoccurrence might therefore raise some legitimate questions about the adequacy of financial reforms implemented since. Based on the December projections, we will have to come to an assessment which of these forces will more likely prevail. The policy mix • How can policymakers raise to the challenge? Four main lessons can be drawn from the major crises we have lived through over the past 13 years. • The first lesson is that our policy responses need to be holistic. In the heat of the battle, the right mix of fiscal, monetary and financial policies is needed. All of them need to play their part. Interactions between them are important, as in earlier crises. • The second lesson is that within this holistic approach, fiscal policy must be in the lead in order to minimize scarring of our production capacity. It is important that the fiscal stimulus is not prematurely withdrawn but rather remains geared towards supporting ailing businesses. It may even have to be scaled up to buffer the effect of the renewed containment measures. Timely and correct use of the Next Generation EU Recovery Package can and will play an important role in this respect as well. • The third lesson is that monetary authorities have to stand ready to act and contribute to tackling any escalation of the Corona crisis. But beyond that, there are limits to what monetary policy can achieve. • With renewed fears about a resurgent Corona pandemic and renewed restrictions imposed to contain it, aggregate demand is inelastic with respect to financing conditions. In such a situation, it would seem more fruitful to directly focus on financing conditions to ensure that demand can display its full elasticity once no longer constrained. The best that monetary policy can then do in support of the economic outlook, is to continue to neutralize the tightening effect that the pandemic would otherwise have on the highly accommodative financial conditions that were already in place pre-Corona. • We have announced that at our December meeting we will recalibrate our monetary instruments. This will also include a reflection on the efficiency of the use of these instruments, with a view to providing effective support for the euro area economy. • The fourth and last lesson is that for the post-crisis recovery phase in the euro area, growth-enhancing structural reforms are key, because they attack problems at their roots. The inevitable but unprecedented fiscal spending will raise public deficits and debts substantially. Future generations can only bear and redress such debt burdens if simultaneously structural measures are taken to protect the public investments needed to boost potential growth. • And with this, let me conclude. | netherlands bank | 2,020 | 12 |
Keynote address by Mr Klaas Knot, President of the Netherlands Bank (DNB), at an open event organized by Bruegel, 11 February 2021. | Klaas Knot: Getting the Green Deal done – how to mobilize sustainable finance Keynote address by Mr Klaas Knot, President of the Netherlands Bank (DNB), at an open event organized by Bruegel, 11 February 2021. * * * Thank you. It’s great to be able to speak here. Over the years, Bruegel has become synonymous with excellent and policy-relevant research. Your work helps people like me to do our jobs better. That is also recognized by others. In the “2020 Global Go To Think Tank Index Report” published by the University of Pennsylvania only two weeks ago, Bruegel ranks as the number one non-US think tank in the world. That’s worthy of congratulations! Let me start by taking you back thirty years ago, when Europe stood before the great economic challenge at that time: transforming the crippled communist economies of Central and Eastern Europe into modern market economies. When I worked at the IMF in the late 1990s, in our reports we referred to this group of countries as transition economies. As Bruegel has also pointed out, thirty years later we are all transition economies now. Not only must we make our fossil-based economies carbon neutral by 2050, to prevent catastrophic climate change. But we must do so while recovering from a public health and economic crisis. I focus on climate change, but the challenge is really much broader. It includes all forms of environmental degradation that make our economies unsustainable. Europe’s Green Deal tackles these multiple crises head-on. It is ambitious, it is comprehensive, and it focusses on growth. And with the Next Generation EU recovery package, and reinforcements to the EU budget, it is backed by unprecedented public financial firepower. The new Sustainable Finance Agenda that is coming out soon, will likely provide plans to mobilize much needed private investments. And that is exactly why the best economic response to the COVID crisis is to start implementing the Green Deal as soon as possible. After the euro crisis, after Brexit, Europe is leading the way, which makes me a proud European today. But true leaders not only show the way. They also make sure everyone is on board. The introduction to the European Climate Law proposal states, and I quote: The European Green Deal reaffirms the Commission’s ambition to make Europe the first climate-neutral continent by 2050.’ End of quotation. Laudable in and of itself. But frankly, it would be much better for the planet if, by 2050, we were the last continent to be climate-neutral. Because that would mean that other nations have caught up with us and even surpassed us. And then the whole world will have become climate neutral before the crucial 2050 deadline. I am optimistic that Europe will team up with the new American leadership, and possibly with China and India and others, to form the powerhouse, the engine, that gets the world back on track to meet the Paris agreement. Because in order to get the energy transition really done, we will need to work together in many areas. Because there’s not a European, or an American or a Chinese climate problem, there is only a global climate problem. Now let’s go back to Europe. As we all know, getting the European economy sustainable for future generations requires large investments. A big part of these investments need to be made by the private sector. And for these private investments to scale up sufficiently, and for the financial sector to finance them, we need to get the right conditions in place. What needs to be 1/4 BIS central bankers' speeches done? And what can governments, central banks and supervisors do? That is what I want to discuss with you today. First of all, we need a better business case for green investments. One policy instrument is absolutely key here, and that is to raise the effective price of greenhouse gas emissions. Carbon emissions are the main, but not the only contributor to greenhouse gases. You see, I’m an economist. Some may call it naïve, but I have this firm belief, backed by experience, that for economic transformation to take hold, you need to have relative prices that reflect the true scarcity of economic resources. In this case, by pricing in the climate cost of greenhouse gas emissions. Internalizing the externality. That will make it far easier for firms and households to determine the future value of their assets and liabilities. This will alter their incentive framework. Then, market forces will drive things in the right direction. This ball lies squarely in the court of governments. The EU Green Deal sets out ambitious plans to make carbon pricing more effective, and it is crucial these plans are not watered down. This is the one thing that makes all the other things that we do, much more effective. Secondly, investors and the financial sector need clear and credible transition plans from governments. A plan that provides answers to questions like: what emission targets will be met and when? What actions are necessary to achieve these targets? What regulation is going to be implemented and in what sequence? What investments will the government make itself? How are we going to compensate vulnerable groups? In answering these questions we can draw lessons from the economic transition of thirty years ago. For example, I recall the debate about ‘gradualism’ versus ‘cold turkey’. Some reforms, like changing relative prices, you may have to do as soon as possible. Others, like changes in productive capacity, will take more time. What’s also important is that it should be a plan that will still be in place after the next election. A plan that gives investors a sense of where we are going. That offers perspective, provides opportunities, and reduces investment risk. Here, again, I think the Green Deal goes a long way in fulfilling this need for a comprehensive plan. And now we have to enshrine it in law, work out the details and get it implemented. Apart from carbon pricing and having a plan in place, what else do we need to do to get the money flowing to where it’s green? Well, thirdly, banks, insurance companies and pension funds need to be more aware of the climate risks they face. And manage these risks accordingly. Financial institutions are vulnerable to the physical consequences of a changing climate. Just ask the insurance companies. And, as I said, it is broader than climate change. In last year’s report Indebted to Nature, we showed that Dutch financial institutions alone have over half a trillion euros in exposures to companies with high or very high dependency on a well-functioning ecosystem. Companies whose business may be at risk due to biodiversity loss and other forms of environmental degradation. Financial institutions also run transition risks. For instance, the bank loan provided to a car manufacturer may be at risk if it fails to develop and build clean vehicles that meet new energy regulations and changing consumer demands on time. So climate risk is a new and important driver of financial risk. Financial supervisors must push financial institutions to manage this risk adequately. Just as they do with other risks. Pressing for good risk management stems primarily from our mandate as supervisors to keep financial institutions safe and sound. But there is an important by-product. Once these institutions have a better understandingtask of the impact of climate-related risks on their balance sheets, this will impact their investment decisions. Less money will flow to fossil-fuel investments, and more to green investments. This way, financial institutions can become a powerful force in pushing the green transition. To be honest, I have not yet seen clear evidence of this reallocation effect playing out on a 2/4 BIS central bankers' speeches significant scale. For one thing, it’s difficult for banks and other financial firms to manage their exposures as long as they lack good information about what is green and what is not. That brings me to my fourth point, and that is disclosure. The information that the financial sector uses is only as strong as the corporate disclosures it is built upon. That is why the quantity, quality and consistency of corporate reporting on sustainability-related information must improve. Credible and comparable information should be readily available for all market participants, shareholders and other stakeholders. This calls for a global solution. I believe the reporting of such information is most effective when it is aligned with the requirements of global accounting standards, and therefore reflected in the audited annual accounts of companies. This also ensures a level playing field across jurisdictions. I think the International Financial Reporting Standards Foundation, the IFRS, is best positioned to set such standards. Therefore I am happy that the IFRS has recently announced to take steps in that direction. Europe, as a frontrunner, has a key role to play in making this global effort succeed. The Italian G20 Presidency has asked the Financial Stability Board to explore how progress can be made here, based on the Recommendations of its Task Force on Climaterelated Financial Disclosures. Finally, European capital markets need to supply more risk capital. At the moment, European firms mainly depend on banks for their funding, and to some extent on capital markets. They only have limited access to private funding markets, which are very small in the EU, at least compared to the US. We need European financial markets to supply more diverse types of risk capital needed to fund the energy transition. Risk capital that typically comes from venture capitalists, private equity funds, and investment funds. And we also need to do something about the existing carbon-bias in European capital markets. In that respect, I think the European Commission’s action plan for the Capital Markets Union could be further improved by stimulating better access to risk capital for green investments. At the same time, funding of non-green investments will need to become more expensive. Apart from carbon pricing, better disclosure is, again, key here. Once it becomes clear for investors that a company’s foot print is not sustainable, risk premia will rise. Central banks can also help to correct the carbon bias in capital markets. In the euro area, central bank purchases of corporate bonds follow a market neutrality principle. This means that the purchases reflect the broader corporate debt market. But what does this neutrality mean if there is a carbon bias in European capital markets because the relative price of carbon emissions is distorted? Central banks could explore how, within the boundaries of their mandates, they can redesign their monetary policy instruments to prevent such biases from occurring, and instead contribute to unlocking more green investments. We could take the existing EU policies, such as the Non-Financial Reporting Directive and the EU taxonomy for sustainable activities, as a starting point in this respect. I spoke about the need for carbon pricing and transition plans. About the need for good risk management and disclosure. And the need for more supply of risk capital. When it comes to the role of the financial sector, I may have inadvertently left you with the impression that finance always follows the real economy. That if governments and central banks and other policymakers and standard setters provide all the right conditions, then funding for the green transition will follow suit. Although I think this is largely true, it is not entirely how I see the role of the financial sector. Financial market players should not wait for all the regulations, and conditions, and perfect data sets to be in place before they can have impact. They perform a crucial role in the economy by helping companies to grow and create jobs and wealth. That means they have a social responsibility of their own to make sure that their business models support a sustainable economy. It is good to see that many financial institutions are working on reducing their carbon footprint. To them I would say, keep up the good work, and branch out 3/4 BIS central bankers' speeches where possible. And to the others I say, don’t just talk the talk, but also walk the walk. Maybe only now, thirty years later, we fully realize how much courage it took for our Central and Eastern European partners to embark on their bold experiment. Without an existing blueprint. Under economic circumstances that make our troubles today look relatively benign. But they had little choice. And neither do we. So let’s learn from their experience and take courage from their example. Even if we do not yet know exactly what a carbon-neutral economy looks like, and how it will change our everyday lives. The EU Green Deal is ambitious and bold. And now we have to get to work to implement it and to fund it. And at the same time, to reach out beyond our borders. To work together with governments, regulators, private investors, financial sector, climate experts, and central banks from all countries. To overcome the policy challenges. And to make sure that we meet the Paris Agreement targets, and tackle climate change in time. 4/4 BIS central bankers' speeches | netherlands bank | 2,021 | 2 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Eurofi High Level Seminar 2021, 16 April 2021. | Klaas Knot: From intensive care to full recovery - finding the way out of the Covid crisis Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Eurofi High Level Seminar 2021, 16 April 2021. * * * Thank you for having me. Eurofi is an important forum for high-quality discussion between policymakers, regulators and representatives from all parts of the financial world. As all these stakeholders hold a piece of the Covid recovery puzzle, it’s good Eurofi was able to go ahead with this event. Even if we can’t be physically together in the same room. Today I want to make some observations relating to the exit path from the Covid-related economic crisis. Where do we stand? What can we expect this year? And how should policymakers proceed, as the European economy gradually recovers? We could compare the European economy with a patient recovering from a severe accident. So far, our efforts have been directed at stabilizing the patient. I would call this the emergency phase. With the vaccine roll-out underway, I think we can say we are approaching the end of this phase. This means we can now gradually begin to focus on the second phase, which I would call the recovery phase. The patient is stable, but is still dependent on life-support systems and medicine. As the doctors consider the rehabilitation program, their task is to slowly reactivate the patient, closely monitor progress, and make sure medical care is not scaled down prematurely. Only when recovery is clearly underway can we start focusing on allowing the patient to leave the hospital, and to build up resilience to possible future adversities. This is the third phase, which we might call ‘rebuilding resilience’. Let’s first see how the patient is doing, now that we are approaching the end of the emergency phase. The euro area economy is forecast to rebound by more than 4% this year, after contracting by over 6% in 2020. Insolvencies and unemployment have been relatively subdued until now. Strange as it may sound during the worst economic downturn since World War II, the economy has done consistently better than we anticipated about a year ago. Of course, massive fiscal, monetary and prudential support made all the difference here. For example, some studies suggest Covid-related failure rates of SMEs in Europe would have been between 9% and 18% in the absence of government support. Nevertheless, the European corporate sector has been hit hard. Particularly those sectors that rely on physical proximity, such as retail, hospitality, entertainment, and travel. Or sectors exposed to natural resources and global supply chains, or those where public support measures are absent. For some of these industries the shocks are temporary, such as for hospitality. Or they will recover if they manage to adjust their business models. In other industries, shocks may have more permanent effects. Business travel, for instance. Similarly, the long-term shift to online retail has likely accelerated. In such cases, a temporary shock may spur developments which become permanent. The banks have been the bright spot in this story so far. They have generally remained resilient and continued to provide credit to the real economy. Their good position is in part thanks to the post-financial-crisis reform agenda including the build-up of more robust buffers. But also because banks have been shielded from large losses due to low insolvency rates. And low insolvency rates, as we have seen, are in turn induced by support measures, such as government guarantees on bank lending. As a result, the policy response to the crisis has 1/3 BIS central bankers' speeches increased the dependency of governments, banks and business on one another. At the moment, this sovereign-corporate-bank nexus – as some have named it – is vital in supporting the economy. But the nexus also means sovereigns are increasingly exposed to corporate risk, and vice versa. This might become an issue if many businesses suddenly were to go bankrupt. Rising credit losses for banks may require governments to provide more support and pay out on guarantees. That would further increase pressure on public finances. Conversely, rising sovereign risk premia could also affect banks through their domestic bond holdings. In the euro area debt crisis only a decade ago we experienced how a vicious circle between governments and banks may lead to financial instability. Luckily, the risk of such a doom loop has diminished with the vaccines and the prospect of economic recovery. But at the same time, it is clear that the virus will continue to linger for quite some time to come. So obviously, governments will be looking for ways to lift restrictions on the economy where possible. Apart from external factors, the corporate-sovereign-banking nexus raises the stakes for finding the right exit path from the economic crisis. Finding this path involves striking a balance between two risks. On the one hand, policy support involves costs. The fiscal costs are most visible. But there are other, more indirect, costs as well. The lockdown and indiscriminate government support prevent market forces from doing their job. A dynamic economy needs to constantly renovate itself through creative destruction, a process which is now impeded. And if we keep the patient on medicine for too long, withdrawal symptoms will increase. On the other hand, if we retract policy support too quickly, there is a good chance that the patient will stumble and fall, putting a healthy recovery back for many months. So policymakers will have to be constantly mindful of this trade-off, observe the patient very closely, and adjust the pace and sequence of tapering measures accordingly. In terms of the European economy – once we approach the recovery phase, we could start discussing the withdrawal of emergency support measures, which would also mean gradually allowing market forces back in. However, we should tread carefully in all scenarios, because the risk of retracting policy support too quickly will likely continue to outweigh the risk of unwinding it too slowly for some time to come. This is especially true for fiscal policy. It’s important that governments do not withdraw their fiscal stimulus until we have made a good start with the recovery. This may well take us to year-end at least. Once the worst is over, fiscal spending can slowly shift from emergency to recovery. This means gradually replacing general blanketed support with more targeted support, and income support with public investment. The Next Generation EU Recovery Fund will be a key building block to get this investment going. This helps meeting the challenge of the much-needed energy transition, and raises the growth potential of our economies. And growth is something that we will also need very badly to bring down sovereign debt levels. Monetary policy in the Eurozone will have to continue to support the recovery. As we are in the silent period today, all I can do is repeat that generic statement we have been making numerous times. Next to fiscal and monetary policy, an important question is how to deal with the rise in corporate debt levels. Under the warm blanket of government support programs, the financial position of corporates has deteriorated. As policymakers start to withdraw support, even if they do so gradually, we will likely see a rise in the number of business that are not going to survive. To some extent this is inevitable. For example in the case of firms that were already vulnerable before the crisis. Or firms whose business models are no longer viable due to post-Covid changes in consumer preferences. But Covid-related legacy debt should not be a reason for firms that are intrinsically viable to go out of business. In a market economy, normally bankruptcy is an important agent for renewal, but it is also a costly one. If applied indiscriminately and 2/3 BIS central bankers' speeches unnecessarily, it is bad for employment, bad for creditors, and bad for the economy. So under the current circumstances, we should look for more targeted and less costly solutions where possible. That might involve corporate debt restructuring where banks and other private creditors, and also tax authorities agree to provide some relief. This could help stem the build-up of non-performing loans. That is why I welcome the Commission’s NPL Action Plan. What I like about the plan is that in addition to cushioning the blow for corporates and banks, it supports a European market for bad debt. It is good to see the progress that’s being made in several places and it’s important to take further steps here. This is a good moment to say something more specific about the banking sector. As insolvencies are expected to rise, banks will see their non-performing loans increase. Fortunately, banks have strengthened their buffers in the preceding years and have taken provisions against the incoming Covid impact. These now constitute two solid lines of defense. But still banks are bracing for impact. Under these circumstances prudential authorities should monitor developments closely. There is a myriad of non-fiscal support measures in place at the moment, that enable the financial sector in continuing to provide credit to the real economy. A careful exit requires that we first get a clear view of what individual measures are in place and what the impact, both individually and in combination, would be if they were lifted. In other words, we should be able to look through the various kind of support measures, and be able to see what is going on below the surface of banks’ balance sheets. For instance, what is the effect of the IFRS9 transitional arrangement on capital ratios? Mapping the impact of non-fiscal support measures will help to design a smart exit path without material cliff effects, and should support authorities to provide clear guidance to financial institutions. Only when the recovery is clearly underway is it time to start restoring the buffers in the economy that have been used to absorb the Covid shock. This is the third phase, which I called ‘rebuilding resilience’. In this phase, which I am happy to discuss in more detail at some later Eurofi event, we will have to focus on further improving the growth potential of the European economy. We will have to bring government debt on a path to more sustainable levels. We will have to repair the resilience of the financial system, by restoring buffers in the banking sector, including the build-up of more releasable buffers. And we will also have to address weaknesses in non-bank financial markets. In short: getting the patient back into a healthy condition and resilient against future adversities. Although this phase is essential, it is important not to rush things. At the risk of repeating myself: we first need to have a robust recovery in place. Dear friends, Europe will get through this crisis, both in terms of health and economically. We rushed to the emergency and threw everything we had at the patient. And now our aim is, and should be, full recovery. That requires time and careful treatment. So let’s continue the good work in close cooperation and get the European economy back on her feet again. Thank you. 3/3 BIS central bankers' speeches | netherlands bank | 2,021 | 4 |
Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, at a panel of the CF40, Euro50 Group and Peterson Institute for International Economics (PIIE) conference on "The Dollar, the Euro and the Renminbi in the new geopolitical environment", 27 March 2021. | International spillovers and the ECB’s monetary policy Klaas Knot CF40, PIIE, Euro50 Group – “The Dollar, the Euro and the Renminbi in the new geopolitical environment”, March 27th, 2021 Introductory remarks – talking points 1. • Setting the stage In my remarks, I want to discuss the international setting within which monetary policy inevitably will have to be assessed. In that regard, I will also focus on the role of international spillovers in the conduct of ECB’s monetary policy. • To set the stage, let me review the recent developments in the US. Then I will address the question how higher US inflation expectations and bond yields affect euro area financing conditions and how this relates to the ECB’s policy response. 2. • US financial market developments Perhaps the most widely debated topic within financial markets over the last weeks centers around the effects of the fiscal package passed by the Biden administration. As a result, market participants have taken into account the possibility of a high inflation scenario once again. This is – amongst others – reflected in the slope of the US yield curve, as measured by the spread between 10-year and 2-year rates. This spread currently resides at its steepest level since 2015. • The recent steepening is, in fact, a story of two tales. In the short end of the curve the Federal Reserve’s commitment to keep front-end rates lower for longer plays an important role. Simultaneously the upward pressure on the longer end signals a brighter economic outlook, which is – at least in part –driven by the surprisingly large fiscal stimulus package. • Decomposing the recent yield curve dynamics – as done here on Chart 1 – confirms that inflation expectations (corrected for the inflation risk premium in light blue) have been increasing substantially in the short end. In combination with the Fed’s forward guidance, this has led to a fall in real rate expectations (depicted in grey). • Chart 1 also shows that the increase of the longer end of the curve, where inflation expectations are arguably better anchored, was instead largely driven by an increase in the real term premium (blue) and the inflation risk premium (in dark blue). • First, the observation that real term premia increased is consistent with the fact that the fiscal stimulus will be, by and large, deficit-financed. International spillovers and the ECB’s monetary policy — 1 • Second, recall that the inflation risk premium is the compensation demanded by investors to hold financial assets that are subject to inflation risks. The inflation risk premium is therefore highly correlated with economic growth. An upward shift in the perception of potential economic growth, as driven by outsized fiscal stimulus, therefore first trickles into the inflation risk premium component. This is because there is still a lot of uncertainty surrounding the effects and definitive composition of the fiscal package. Chart 1: Decomposition of the weekly changes in US yield curve since end of July 2020 Inflation Risk Premium Real Term Premium Real Expected Rate Treasury yield 2,00% 2,00% Chart 1A: US 2 year 1,50% 1,50% 1,00% 1,00% 0,50% Expected Inflation Rate Chart 1B: US 10 year 0,50% 0,00% 0,00% -0,50% -0,50% -1,00% -1,00% -1,50% -2,00% Jul-20 Sep-20 Nov-20 Jan-21 -1,50% Jul-20 Sep-20 Nov-20 Jan-21 Source: DNB staff calculations. Note: Decomposition based on an affine term structure model for the US treasury and inflation-linked swap curve. Weekly data. Last observation 19-032021. 3. Spillovers to the euro area • Now a crucial question in the conduct of our monetary policy is if and how these developments spillover to the euro area. I will argue that the rise in longer-term interest rates in the euro area since the beginning of this year reflects, at least in part, spillovers from the US arising from the improved prospects for global growth. • To illustrate this, chart 2 shows a historical decomposition of the changes in the euro area 10-year OIS rate based on a two-country time series model.1 This model tries to disentangle several driving factors behind the recent rise in euro area risk free yields, such as the effect of policy and macro news on both sides of the Atlantic. 1 The Chart is based on a two-country Bayesian Vector Autoregression Model estimated on daily data with identification of structural shocks based on sign restrictions. International spillovers and the ECB’s monetary policy — 2 • Three observations stand out. First, an important factor behind the increase in euro area yields might be a continued decline in what is here called “global risk”. This decline in the global risk component is still a reversal from the initial flight-to-liquidity flows observed at the onset of the Covid-19 crisis. Specifically, against the backdrop of an improved economic outlook, investors increasingly switch from fixed income into more risky asset classes. • The second and third observation are that both US macro news (the dark blue component) and US policy (the light blue component) are driving factors behind the recent rise in yields. More specifically, these two factors turn positive in early January when the Democrats gained control over the Senate by the surprise win in Georgia. As of that moment, the expectations surrounding the size of a potential fiscal package have significantly grown, which resulted via both the US macro and US policy component in upward pressure on euro area yields. Chart 2: Decomposition daily changes in the 10-year euro area OIS rate 0,3 EA Policy US Macro EA Macro Global Risk US Policy EA 10Y OIS 0,2 0,1 -0,1 Dec-20 Jan-21 Feb-21 Mar-21 Source: DNB staff calculations. Note: Decomposition based on a two-country BVAR. Shock identification based on sign and magnitude restrictions. Daily data. Last observation 23-03-2021. • Another channel via which an improved global economic outlook affects the euro area are oil prices and ultimately via expected inflation. Charts 3 and 4 illustrate this by highlighting that the rise in oil prices was largely driven by demand side factors. The dominance of demand-side factors behind the rise of oil prices confirms that the improving economic outlook is an important driver. Driven by the rising oil prices and the improving outlook, market-based measures of inflation expectations have surged as well, as depicted in Chart 4. International spillovers and the ECB’s monetary policy — 3 Chart 3: Decomposition daily changes in oil Chart 4: Euro area ILS and oil prices price Supply Demand 5y5y EUR inflation swap rate Oil price ($, Brent, RHS) 1,7 1,5 1,3 -10 -20 1,1 -30 -40 0,9 -50 -60 Dec-19 0,7 Mar-20 Jun-20 Sep-20 Dec-20 '19 '20 '21 Source: DNB staff calculations. Note: Decomposition of the oil price into demand and supply factors based on a VAR model. Identification based on sign restrictions. Daily data. Last observation: 23-032021. 4. The ECB’s policy response • Not every rise in yields is inconsistent with our pledge to maintain favorable financing conditions. For instance, a rise in nominal rates due to better growth and inflation prospects may not cause immediate worries. In contrast, rising interest rates due to for example dysfunctioning markets warrants a corresponding policy intervention. • The recent increase in yields was largely driven by benign factors. Taken at face value, the rise in inflation expectations is a welcome development. Yet the sizeable and persistent rise in euro area yields due to a faster economic recovery in the US could prematurely tighten financing conditions for the euro area economy, which is inconsistent with countering the downward impact of the pandemic on the projected path of inflation. This has led to the decision by the Governing Council to frontload some of its purchases under PEPP until the improved growth outlook for the euro area itself would stand on firmer ground. Chart 5 shows that the upward pressure on the real rate component has been neutralized. • That being said, however, it is important to note that we stand ready to adjust our monthly purchases in either direction, if required, to maintain favourable financing conditions. International spillovers and the ECB’s monetary policy — 4 Chart 5: Decomposition of the 10-year OIS rate into inflation and real rate 0,4 0,3 0,2 0,1 -0,1 -0,2 Dec-20 Jan-21 Inflation component Feb-21 Real rate component Mar-21 10 year OIS swap Note: Graph shows the cumulative change since 1 December 2020 (in percentage change). The real rate is calculated by subtracting the inflation-linked swap rate from the nominal OIS rate of the same maturity. Daily data. Last observation: 2603-2021. International spillovers and the ECB’s monetary policy — 5 | netherlands bank | 2,021 | 4 |
Keynote address by Mr Klaas Knot, President of the Netherlands Bank, before the International Symposium of the National Association for Business Economics, 11 May 2021. | Klaas Knot: Rebuilding resilience - the financial system after the Covid crisis Keynote address by Mr Klaas Knot, President of the Netherlands Bank, before the International Symposium of the National Association for Business Economics, 11 May 2021. * * * It’s an honor to speak at this International Symposium of the National Association for Business Economics. I think we all share a fascination for economics here. Having worked in academia, the IMF, the Dutch finance ministry and the central bank, I live and breathe economics. So I feel very much at home here. “My friends, I want to talk for a few minutes with the people of the United States about banking.” So began, on March 12, 1933, the first of about thirty fireside chats that president Roosevelt delivered over the radio. It was eight days after his inauguration. He had spent his first week coping with an epidemic of bank closures that affected households in every state. Three days after closing down the entire American banking system, Congress passed the Emergency Banking Act. Roosevelt used it to create federal deposit insurance when the banks reopened. That Sunday night, on the eve of the end of the bank holiday, Roosevelt spoke to a radio audience of more than 60 million people. He told them in clear language “what has been done in the last few days, why it was done, and what the next steps are going to be.” The result was a remarkable turnaround in the public’s confidence. Since this, almost iconic, banking crisis of 1933, we have seen financial crises in all shapes and sizes throughout the world. And now, the Covid crisis poses yet a new challenge to the financial system. How has the financial system stood up to this latest test? And what can we learn from it for the future? These are the questions I want to address with you today. First, I will reintroduce you to the concept of systemic risk. I will argue that this has been the primary ingredient in financial crises throughout history, from 1933 to the 2008 global financial crisis. I will then discuss what governments and regulators have done to strengthen the financial system. I will explain how the financial reforms of the past ten years helped to cushion the impact of the Covid crisis, especially in the banking sector, but that systemic risk revealed itself in other parts of the financial system. I will end by discussing how we can address these new vulnerabilities in the financial system and strengthen its overall resilience. Let us start with systemic risk. Systemic risk can be described as the risk that an initial shock may spread through the system to such an extent, that otherwise healthy and solvent financial firms and markets are severely affected. It can even lead to the breakdown of the entire financial system, severe economic disruption, and great economic hardship for companies and households. The financial system is more vulnerable to systemic risk than other sectors of the economy. Academic literature gives three main reasons for this. First, many financial institutions are characterized by a liquidity mismatch between assets and liabilities. For example, banks traditionally take deposits that can be withdrawn at very short notice, and they provide long term loans to companies. If, for some reason, depositors want to withdraw their money all at the same time, the bank does not have sufficient reserves to pay out everyone. So the stability of the financial system is highly dependent on confidence. In the case of banks, it is the confidence of depositors in the value of the loan book and confidence that other depositors will not withdraw their money. Importantly, this type of dynamic is not exclusive to banks, as we will see later on. Secondly, participants in financial markets are interconnected by a complex network of 1/4 BIS central bankers' speeches dependencies and exposures. Interconnectedness is inherent in any mature financial system. It allows financing to flow, and provides for diversification and risk-sharing. Yet, imbalances or shocks in one sector can quickly pass through to the rest of the financial system. The third factor that makes the financial sector particularly susceptible to systemic risk, is the intertemporal nature of financial contracts. For example, if you invest in a company’s stock, you have expectations about the cash flows that stock will generate in the future. Expectations that may or may not materialize. Changes in expectations about future cash flows can lead to sudden asset price fluctuations, like stock market crashes, resulting in financial losses. If you combine that with leverage, the consequences may be unpleasant. Liquidity mismatch. Interconnectedness. The intertemporal nature of financial contracts. These three elements make the financial system more vulnerable to systemic risk than other sectors of the economy. We saw the first element at work during the 1933 banking crisis. A collapse in confidence in the banks, and expectations about the behavior of other depositors led to a run on the banking system. The image of people queuing up in front of their banks hoping to collect their savings lives on forever, even in movies. Who can forget the American Christmas classic It’s a Wonderful Life, when Jimmy Stewart and Donna Reed used their honeymoon savings to keep the bank open. We have seen the three elements of systemic risk at work many times since then. For example, during the Asian crisis of 1997, the Russian default crisis of 1998, and of course the global financial crisis of 2008. Having been a witness to all these three crises in the course of my professional career, I must say each one of them was a fresh eye-opener. Throughout history, financial policies have aimed to contain systemic risk and build resilience in the financial system. For example, after the financial crisis of 1907, the Federal Reserve was established to act as a lender of last resort. And after the banking crises of the 1930s, we saw the birth of capital requirements and deposit insurance, in the US and elsewhere. The reforms after the 2008 Global Financial Crisis can be seen in that historic context. Capital and liquidity requirements for banks were raised to increase their loss-absorbing capacity and to withstand an outflow of funds. Capital requirements were raised even further for highly interconnected global banks. And counterparty credit risk was reduced by increasing margin and collateral requirements and by establishing central clearing counterparties. Despite this historic tradition, there was also something new about the post-2008 reforms. This time the reforms were a truly international effort. The G20 nations established a Financial Stability Board that coordinated the development of new policies. The FSB also encouraged these policies to be implemented in a coherent manner across sectors and countries. The FSB was also given the task of monitoring the global financial system for new weaknesses and springing into action at short notice once a new crisis hit. Since modern financial markets do not stop at national borders, that was a very important step. We still reap the benefits from this today, and I will discuss this aspect later on. So we have identified the elements of systemic risk and how this has shaped financial crises and policy responses. Let us now look at how the financial system has weathered the Covid storm. First and foremost, the bold policy response by governments, central banks and supervisors, helped maintain global financial stability and sustain the supply of credit to the economy. Also, the global financial system, at least its core parts, is more resilient than it was ten years ago. This is largely due to the financial reforms in the wake of the 2008 global financial crisis. Thanks to these reforms, banks have been able to absorb the Covid shock. They have continued to provide credit to the economy at a time when it is most desperately needed. Although Covid-related corporate insolvencies will no doubt hit their loan books pretty hard, it seems banks will also be able to 2/4 BIS central bankers' speeches continue supplying credit in the near future. I really want to emphasize this, because it offers a valuable lesson. Many of you probably recall the tough discussions we had only a few years ago about the cost of the rising capital requirements for banks, and the possible negative impact on credit supply. But if we had not done this, governments would now have to deal with a crippled banking sector in full deleveraging mode, on top of an economy starved of credit. We would have had a crisis within a crisis. In other words: building resilience into the financial system in good times may seem expensive, but over the long run it is the most cost effective thing to do. So the banking sector has withstood the Covid stress test pretty well. However, you and I know that not everything went smoothly in the financial system, as events in March last year showed. Let us go over some of the key developments that happened. As countries went into their first lockdown, and the scale of the Covid impact became apparent, investors and corporates fled for safety and liquidity. You probably remember how firms everywhere tried to tap the capital markets. Money market funds experienced significant outflows. And some open-ended funds faced large redemptions. Initially, yields on risk-free assets fell rapidly at the end of February and early March due to the flight to safety. However, this became an abrupt and disruptive ‘dash for cash’ in mid-March, as investors demand for cash and near-cash assets rose sharply. This resulted in selling pressure on usually safe and liquid assets such as government bonds. Risk-free yields began to rise sharply and the financial conditions facing major economies tightened. Looking at a Bloomberg screen during that period sometimes felt like being back in September 2008. Central banks had to take extraordinary measures to stabilize markets: asset purchases, liquidity operations, and backstop facilities for specific financial entities. While in 2008 central banks had to bail out the banks, this time they had to bail out a number of financial markets. Some of this may have been inevitable given the enormity of the economic shock. But weaknesses in the non-banking part of the financial system made matters worse. The FSB carried out a thorough review of the March market turmoil. It was published last November and I recommend you read it. As the review showed, liquidity mismatch, interconnectedness, and sudden changes in expectations, those systemic risk factors that I mentioned earlier, again played a key role in propagating the initial shock. It seems that over time, investments in money market funds and open-ended funds came to be seen by investors as just as liquid and safe as cash. As doubts started to grow about the ability of these funds to liquidate their assets on demand, investors wanted to be at the front of the redemption queue. In other words: as it emerged that these funds had a liquidity mismatch without the buffers to sustain it, a stampede was triggered that was in essence not so different from the classic bank runs we saw in the 1930s. Next, the March events highlighted the dependence of the system on readily available liquidity. If liquidity strains emerge, in money market funds and open-ended funds, through margin calls and in core bond markets, vulnerabilities spread quickly through the financial system. One of the important post-crisis reforms I mentioned earlier, was the greater use of margining and central clearing through the CCPs. Thanks to this, the market stress did not result in widespread concerns about counterparty risk – as we saw in 2008. But violent price swings in financial markets translated into margin calls that may have been larger than expected. This put sharp liquidity pressure on those on the wrong side of derivatives exposures, adding to demand for liquidity in the system. All this should not surprise us. Money market funds already played a crucial role in propagating the initial shock of Lehman’s collapse in 2008. Maybe you remember the speech that Paul 3/4 BIS central bankers' speeches Volcker gave at a NABE conference in 2013, when accepting the Lifetime Achievement Award for Economic Policy. On that occasion he expressed his concern about the weaknesses in the regulation of money market funds. With the financial reform agenda after 2008 being heavily focused on banks, and much less so on non-banks, vulnerabilities in the financial system moved from the banking sector to the nonbank financial sector. This is what I call the ‘waterbed effect’. Pressing down on one end of the financial system will cause risks to pop up elsewhere. And, indeed, since 2008 non-bank financial intermediation, or NBFI, has grown much faster than bank intermediation. It now accounts for about half of all financial assets worldwide. So, whereas in the aftermath of the previous crisis the emphasis was very much on the banks, we now have some catching up to do when it comes to reducing systemic risk in non-bank financial markets. Where there is a liquidity mismatch, a complex network of exposures, and potentially sudden price swings, it is key we have buffers, flexibility in regulation and safety valves in the system, to contain systemic risk. Financial institutions need buffers to absorb losses and liquidity shocks. Regulation needs flexibility in order to allow institutions to use these buffers. And the system needs safety valves, like margining, to prevent too much risk pressure being built up. In July, the Financial Stability Board will publish a consultation report with proposals to improve the resilience of money market funds. This work will also consider the relationship between these funds and short-term funding markets. We need to look in particular at whether investors conceive money market funds as equivalent to deposit accounts. And if so, whether money market funds have the resilience to meet the consequent liquidity demands in the event of severe stress. This work will soon be followed by ongoing efforts focused on other open-end funds, margining and bond market structure, and liquidity. The FSB also continues to advance work to improve CCP resilience and resolvability. Maintaining a strong global financial system requires a global approach. Here, we have one big advantage. We can fall back on a framework of international cooperation that has been tested and proven to work. The Financial Stability Board has coordinated important financial reforms in the past and will continue to do so in the future. Indeed, coordinating the post-Covid reform agenda to rebuild financial resilience will be central to its work well into next year. Almost ninety years have passed since that American president with Dutch ancestral roots first took to the airwaves to reassure the public. Yet today the challenge to contain systemic risk and keep the financial system resilient is as important as ever. The policy tools we have at our disposal are now much more powerful. But the complexity and dynamism of the financial sector are also far greater. It’s a job that’s never done. So let’s make use of the architecture for international cooperation that we have built up. And ensure the post-pandemic financial system is resilient, and stays strong enough to meet future challenges. Thank you. 4/4 BIS central bankers' speeches | netherlands bank | 2,021 | 5 |
Text of the Witteveen lecture by Mr Klaas Knot, President of the Netherlands Bank, at the Erasmus School of Economics, Rotterdam, 11 June 2021. | Speech Klaas Knot - “The case for fiscal stabilization in a low interest rate environment” (c) @Marieke Bijster/DNB In his Witteveen lecture at the Erasmus School of Economics today Klaas Knot argued for a greater role of fiscal policy to stabilize the economy in the current low interest rate environment. He pointed out that the current fiscal framework in the EMU, despite its merits, is not well equipped to deliver that. “In order to make our monetary union more stable, we need a fiscal framework that enhances coordination between member states and allows for a better alignment of monetary and fiscal policy over the entire economic cycle.”, he said. Thank you. It is a great honor to give this lecture. A lecture that bears the name of a man who has greatly influenced economic policymaking. Both in theory and in practice, both at home and abroad. I saw Johan Witteveen a few times in the late 1990s, when I worked at the IMF. As a former managing director he still had his office at the Fund, and he regularly visited to discuss economics and share his views with IMF staff. Although I never intensely spoke to him one-on-one, it was clear to me that after all those years he was still a very respected economist, and that he was held in the highest esteem by those around him. In fact, watching him from a distance, it was easy to imagine John Maynard Keynes himself walking there, in the corridors of the institution of which he was the spiritual father. The association with Keynes is not so strange because, of course, Witteveen was a Keynesian economist. He held the view that fluctuations in aggregate demand can create business cycle fluctuations. And because markets do not always adjust smoothly, he believed that both monetary and fiscal policy have a role to play in dampening these fluctuations. And that their effectiveness in stabilizing the economy depends on how they interact with one another. Witteveen’s views on the importance of monetary and fiscal stabilization policies are highly relevant today. In his spirit, today I will present a case for a more active role of fiscal policy in stabilizing the economy, in a world with persistently low interest rates. I will start by briefly reviewing some of the conventional channels along which monetary and fiscal policy interact in normal times, when interest rates are much higher than they are now. We will then see how this interaction is modified when interest rates are persistently low, and what this implies for the role of fiscal policy. Next, we will move away from the theory and have a look at how fiscal and monetary policy in the euro area interacted in practice. Here we will look in particular at the European debt crisis ten years ago, and compare that episode to the more recent Covid crisis. I will end with some remarks about possible implications for the fiscal framework in the euro area. The channels of monetary-fiscal policy interaction in normal times Let us start by briefly reviewing how monetary and fiscal policy interact in normal times. Firstly, monetary policy affects fiscal policy by influencing the cost of funding for the government, and the sustainability of its debt. If the central bank lowers the policy interest rate or purchases more government bonds, it becomes cheaper for the government to finance its deficit. Moreover, monetary policy affects growth and inflation, and therefore also the differential between real interest rates and economic growth. This interest-rate-growth differential, or simply ‘r minus g’, largely determines the sustainability of public finances. The higher the differential between the interest rate and growth, the greater the build-up of government debt as a percentage of the economy over time. And so the more difficult it is to ensure that the debt remains on a sustainable path in the long run. Conversely, higher economic growth and/or a lower real interest rate reduce ‘r minus g’ and thereby make it easier for governments to remain solvent. The conduct of monetary policy not only influences the cost, but also the effectiveness of fiscal policy. For example, fiscal expansions are likely to have a stronger impact on economic activity when they are accompanied by a loose monetary stance from the central bank. This is because, in normal times, when the government raises expenditure and lets the deficit go up, interest rates will rise. But with higher interest rates, firms and households will spend less. This ‘crowding-out’ effect offsets the positive effect of the fiscal expansion. If the central bank keeps the interest rate low, this effect is much weaker, and the fiscal expansion will have a more positive effect on output. So monetary policy impacts fiscal policy. But vice versa, fiscal policy also influences the effectiveness of monetary policy. For example, changes in taxes, government spending and public wages affect the demand for goods and services, which in turn drives inflation. Such fiscal policy actions may either support or undermine the ability of the central bank to achieve its price stability objective. I will illustrate these monetary-fiscal interdependencies using a standard IS-LM model [Figure 1]. Figure 1. The effect of monetary policy depends on fiscal policy For those of you who do not have a stack of macroeconomics textbooks lying on your bedside table, here’s a quick reminder. The IS-curve shows all combinations of the interest rate and level of output for which the market for goods and services is in equilibrium. The LM-curve represents equilibrium in the monetary sphere of the economy, that is simply where money supply equals money demand. The interest rate and output level at the intersection of the IS and LM curves, at point A, satisfy equilibrium in both markets Now suppose the central bank expands the money supply and thereby reduces the interest rate. This is reflected by a rightward shift of the LM curve, the blue dashed line being the new LM curve. The ultimate impact on output then depends, to a large extent, on how fiscal policy reacts to this monetary expansion. If fiscal policy remains constant, meaning government spending and taxes are left unchanged, then output rises because the lower interest rate stimulates investment. The economy shifts from A to B. If fiscal policy is loosened and the government raises the budget deficit, then the positive effect on output is amplified. In that case, the fiscal expansion shifts the IScurve to the right, as shown by the yellow dashed line, and the economy settles at point C. Here output is higher than if fiscal policy remained constant. Now let’s look at the opposite case. If fiscal policy is tightened and the budget deficit reduced, for example through a tax hike, the positive change in output brought about by the monetary expansion will be more muted. In that case, the fiscal tightening leads to a leftward shift of the IS curve and output falls. If the fiscal tightening is sufficiently strong, the positive effect on output is fully offset. The economy shifts from A to D. As an aside, you can see that the amplification then takes place in the lowering of interest rates, a heavily debated development in the Netherlands, with far reaching consequences for bank profitability, pension solvency etc. But here I will abstain from all of these financial stability consequences and just focus on output and inflation. So monetary policy influences the effectiveness of fiscal policy, and vice versa. The important thing to remember is that in order to effectively stabilize the economy, we need a well-aligned monetary-fiscal policy mix. A central bank combatting low inflation would benefit from loose fiscal policy, while a crisis-fighting fiscal authority would gain from the support of accommodative monetary policy. Of course, properly aligning monetary and fiscal policy may be more difficult in a monetary union that consists of a single central bank and many different national fiscal authorities. We will talk more about the challenges for monetary-fiscal interactions that are specific to monetary unions later on. The role of fiscal policy in times of persistently low interest rates Now let’s talk about monetary-fiscal interactions in times when interest rates are persistently low. At this point I am going to introduce a new character to the story: the natural interest rate. The natural interest rate, or r* as it is often called, is the interest rate at which the demand for, and supply of, capital are in equilibrium, and the economy operates at full employment. If the central bank wants to cool off the economy and bring inflation down, it needs to set its policy interest rate above the natural rate. On the other hand, to stimulate the economy and to raise inflation, the policy rate should be set so as to push the interest rate below the natural rate. And here comes the problem for central banks. Stimulating the economy and raising inflation may not be feasible if the natural interest rate is very low. In that case, the policy rate needed to stimulate the economy might lie below the effective lower bound that exists on the nominal interest rate. Below this lower bound, further interest rate reductions are either impossible or will simply not induce higher borrowing by households and firms anymore. They just keep their money in the form of cash rather than in savings accounts or bonds. The effective lower bound therefore limits the scope for monetary stimulus. The interplay between the natural rate of interest and the monetary policy stance, and the constraining role of the effective lower bound, is illustrated in this figure. [figure 2] Figure 2. The effective lower bound limits the scope for monetary stimulus For simplicity, let’s assume the inflation rate is zero, so the nominal and real interest rate are the same. When the central bank sets the interest rate above the natural rate, monetary policy is said to be contractionary. This is indicated by the blue area. If the interest rate is set below the natural rate, monetary policy is expansionary. This is indicated by the yellow area. Because of the effective lower bound , and for a given level of inflation, there is a limit to the scope for expansionary monetary policy. The lower the natural rate, the less room there is for the central bank to provide monetary stimulus. On the other hand, a higher natural rate increases the scope for monetary policy to be expansionary. If we bring inflation back into the story, then higher inflation would also increase the yellow area in the figure, as it would push the ‘real effective lower bound’ more to the left. Remember, the absolute lower bound is on nominal rates; higher inflation therefore lowers the lower bound on real interest rates and in doing so creates more space for monetary stimulus. The effective lower bound is like the black hole of monetary policy. We cannot directly observe it. But we know that monetary space disappears if the natural rate approaches the lower bound. Because that is the point beyond which the central bank’s interest rate cannot reach. So a low natural rate of interest is a challenge for central banks. And that is exactly what has happened. [Figure 3] Figure 3. The natural rate of interest in the euro area has declined As you can see in this chart, empirical evidence suggests that the natural interest rate has been on a downward trend in the past few decades, both in Europe and other parts of the world. Estimates for the euro area put the current natural rate at, or even below, 0%. Several structural forces underlie this so-called secular decline in r*. Think of ageing, rising inequality, higher risk aversion, weak productivity growth and lower investment demand. They all tend to lead to an excess demand for safe assets. Because most of these trends are likely to continue in the future, the natural rate is expected to remain low for some time. This means that the effective lower bound will limit the central bank’s room for manoeuvre more often in the future. So spells of very low interest rates mean trouble for central banks. But they may be good news for governments. Low interest rates tend to increase the impact of fiscal policy on the economy. In fact, recent empirical evidence shows that the impact of government spending on output is larger when the effective lower bound on interest rates is binding. Intuitively, this makes sense. Raising public expenditure in a low interest rate environment does lead to more private spending, because the nominal interest rate remains low and is expected to remain low. In fact, a fiscal expansion could actually have a crowding-in effect through an increase in inflation, and inflation expectations, and thereby a reduction in the real interest rate. So people are going to spend more because they expect prices to increase in the future, rather than to spend less because government spending raises interest rates. In theory, this is good news, because it means that, in a low interest rate environment, expansionary fiscal policy is capable of helping the central bank in stimulating demand for goods and services, raising inflation, and escaping the effective lower bound on interest rates. However, the flipside is that contractionary fiscal policies at the effective lower bound can keep aggregate demand and inflation low, and real interest rates high. This traps the economy in the low interest rate environment for longer. To make matters slightly more complicated, in a low interest rate environment, the impact of fiscal contractions and expansions is not symmetric. The negative effect of contractionary fiscal policy is larger than the positive effect of expansionary fiscal policy. That’s because of the non-linear nature of the effective lower bound, which means that the interest rate can move upwards more easily than it can move downwards. In order to understand this, let’s look again at the IS-LM model from before.[Figure 4] Figure 4. Fiscal policy is more potent near the effective lower bound, but fiscal contraction more so than fiscal expansion. To characterize the economy in which the interest rate is near its effective lower bound, in this chart we now draw the LM curve as a convex function. The closer the interest rate is to its lower bound, the less responsive output becomes to changes in the interest rate and so the flatter the LM curve is. For the same reason, we draw the IS curve as a concave function: the lower the interest rate is, the smaller the effects of interest rate changes are on investment and output, and so the steeper the IS curve is. Now consider two cases. In the first case, the government decides to pursue fiscal expansion. This leads to an increase in aggregate demand, as reflected by a rightward shift of the IS curve. The new IS curve is the yellow dotted line called IS prime. This pushes the economy away from the effective lower bound. The rise in aggregate demand drives up the interest rate. This rise in interest rates makes it less attractive for firms and households to spend, just as in our previous example in the standard IS-LM model. This crowding-out effect limits the overall effect of the fiscal expansion on output. In the second case, the government instead implements a contractionary fiscal policy. This leads to a reduction in aggregate demand and so the IS curve shifts leftward. The yellow dotted IS-curve with the double prime. Because the IS curve now moves along the flatter portion of the LM curve, the fiscal contraction leads to a relatively small reduction in the interest rate. This small interest rate reduction does little to offset the fall in output. Therefore, the negative effect of the fiscal contraction on output is larger than the positive effect of the fiscal expansion. In a more sophisticated model of a dynamic economy, a fiscal contraction at the effective lower bound can be shown to do even more harm by reducing inflation expectations and raising the real interest rate. This further depresses private spending and inflation. Ok, let’s pause here for a moment. I realize that for some of you, this was all a bit intense. Sometimes, the economics professor in me gets the upper hand. Yet it’s useful to grasp some basic theory, in order to appreciate what happened in the euro area over the past ten years and to understand the policy challenges that lie ahead of us. As a reassurance, and maybe disappointment for others, the hardest part is behind us. Now the real fun begins. But before we continue, what do you need to have taken in so far? We’ve seen that, in normal times, the mix of monetary and fiscal policy is important for stabilizing the economy. We have also seen that once interest rates are persistently low, the scope for monetary stimulus is reduced, but the effects of expansionary fiscal policy are greater. Governments can then help the central bank by raising aggregate demand and inflation, and shortening the period of low interest rates. Conversely, if in such circumstances the government were to pursue a contractionary fiscal policy, this could trigger a vicious cycle of weak demand, low inflation and high real interest rates. As we will likely have more frequent episodes of very low interest rates in the future, this strengthens the case for a greater role for counter-cyclical fiscal policies. This is more or less in line with what Witteveen argued already more than 50 years ago. Now, before you all get too excited about the potential of fiscal policy, I want to make a few cautionary remarks here. If using the national budget to stabilize the economy in a low interest rate environment is such a good idea, why aren’t governments doing this all the time? Well, first of all, macroeconomic stabilization is not the only objective of fiscal policy. There are lots of other legitimate economic and political objectives, like for example redistributing income. And there are important constraints as well. I will come to speak about debt sustainability in a moment, when we look at the euro area. But there are also, what economists famously call, the implementation and transmission lags. This simply means it takes time, for example, to design and implement a good subsidy policy for the purchase of electric cars. And then it takes time before people actually buy more electric cars. These time lags often prevent fiscal policy from providing the necessary stimulus at the time it is needed, and not when the recovery is already well underway. And even if fiscal policy were not subject to any lags, governments would still face the issue of coming up with the right fiscal package. Are we going to cut labor income taxes or are we going to invest in the digital highway? Or a little bit of both? It isn’t easy. As a Finance Minister, Witteveen was no doubt very aware of that. So when I say that persistently low interest rates strengthen the case for more countercyclical fiscal policy, I’m not saying this should be the new compass for the ship of state to sail by. Other considerations are as important as ever. What I would like to argue is that the macroeconomic stabilization function of fiscal policy has become more important, and should therefore attract more prominence when weighing the various objectives of fiscal policy. Fiscal-monetary coordination in the euro area Now that we have covered the theory, let’s see what actually happened in the euro area. The consensus view before the global financial crisis of 2008 prescribed a clear division of tasks between monetary and fiscal policy. According to this view, an independent central bank should be tasked with stabilizing prices, which would normally have a countercyclical element to it. Fiscal policy should focus on achieving public debt sustainability. This division of tasks was meant to ensure that fiscal problems were not resolved by having the central bank ‘inflate away’ public debt. Also, discretionary fiscal stabilization policy was generally seen as very difficult to implement, for the reasons I just mentioned. Fiscal authorities were therefore advised to take on a more passive role and let the automatic stabilizers do their job. This pre-crisis consensus view is reflected in the institutional setup of our Economic and Monetary Union. While the European Central Bank is mandated to maintain price stability, under complete independence, the member states are required to follow a set of fiscal rules that limit government indebtedness. This is all laid down in the Stability and Growth Pact, or SGP. At the core of the SGP are a set of well-known fiscal rules. The most important ones being that the government deficit should not exceed 3% of GDP and that government debt should not be higher than 60% of GDP. Again, the main purpose of these rules, which continues to be relevant today, is to safeguard the ECB’s independence and to help prevent debt sustainability risks from spilling over from one member state to others. Despite its merits, there was one thing that the EMU fiscal architecture was not designed for. And that was to ensure an appropriate fiscal stance at the union-wide level. A fiscal stance that takes account of the condition of the euro area economy and is aligned with the monetary stance of the central bank. After all, decisions on spending and taxation are the responsibility of national governments. Discretionary fiscal stabilization policy is possible, but only as long as the conditions of the SGP are satisfied. The dominant thinking was that a budget balance close to zero or in surplus in good times would create sufficient fiscal space for automatic stabilizers to stabilize the economy in bad times. This would be enough for fiscal policy to support monetary policy in smoothing out national business cycle fluctuations and ensuring stability of the monetary union. So we thought. Then came the global financial crisis of 2008. And a few years later, the European sovereign debt crisis. These crises taught us the hard way that the pre-crisis consensus view on the role of fiscal policy was incomplete. It was incomplete because it did not take into account episodes in which countries would face a very large shock and in which low interest rates would limit the scope for monetary stimulus. This design flaw of the fiscal architecture in the EMU became painfully apparent during the European sovereign debt crisis. Multiple member states were hit hard by the unwinding of macroeconomic imbalances that had built up in previous years. As fears started to emerge about their debt sustainability, sovereign bond spreads in the euro rea started to diverge, triggering a self-fulfilling crisis. The ECB’s Outright Monetary Transactions and former President Draghi’s infamous “whatever it takes” speech in 2012 signalled the ECB’s willingness, on specific terms and conditions, to act as buyer of last resort of government debt. This eliminated speculative risk premia and helped restore the transmission of monetary policy. Yet in the aftermath of the crisis, binding budgetary restrictions still forced countries to cut public spending and raise taxes. This not only hurt economic growth, but also shifted the burden of macroeconomic stabilization onto the shoulders of the ECB. To make matters worse, this happened in an environment of persistently low interest rates that, as we have seen, makes traditional monetary instruments much less effective. As countercyclical monetary policy at the euro area wide level was unable to offset procyclical fiscal policies at the national level, the recession was prolonged and the subsequent recovery was off to a slow start. [Figure 5] Figure 5. Monetary and fiscal policy in the euro area were misaligned The following chart illustrates the lack of coordination between monetary and fiscal policy in the euro area during and after the European sovereign debt crisis. The bars show the change in the primary budget balance as a percentage of potential output for the euro area as a whole. Positive numbers indicate a discretionary fiscal tightening, negative numbers indicate fiscal loosening. The red bars indicate the years when fiscal policy was procyclical and green bars the years in which fiscal policy was countercyclical. While fiscal policy was initially countercyclical during the global financial crisis, it turned procyclical during much of the European debt crisis. This reflected choices in fiscal policy that were often understandable from a national perspective. But, at a European level, these choices led to an aggregate fiscal stance that was not supportive to economic recovery. Monetary policy, on the other hand, was steadily accommodative during those years, as evident from the ECB’s expanding balance sheet. In the chart, this is shown by the solid white line. So during most of the sovereign debt crisis, monetary and fiscal policy behaved out of sync, rather than working in tandem to stabilize the economy. Now let’s look in the same chart at what happened more recently, during the Covid crisis. This time, the policy response was entirely different. Both monetary and fiscal policy responded to the crisis with unprecedented heft and synchronicity. What helped, of course, was the much more symmetric nature of this crisis compared to the previous one. Every country in Europe was hit in a similar fashion, and in every country it was clear what the desired fiscal response should be. The ECB expanded its quantitative and credit easing instruments, as reflected by the strong growth of its balance sheet. This provided space to governments to increase fiscal spending, without triggering severe stress in sovereign bond markets. In fact, the aggregate discretionary fiscal stimulus in the euro area in 2020 has been estimated to be more than 4% of GDP. By comparison, the global financial crisis prompted a discretionary fiscal stimulus of about 1.5% of GDP. I think this response to the Covid crisis offers important lessons for the fiscal architecture in the euro area. The successful coordination of fiscal and monetary policy was in great part due to the enormity of the economic threat as well as its symmetric nature. From the outset it was clear that we needed an all-out response from both governments and central banks to shield households and firms from income loss and avoid irreversible damage to the economy. Under these circumstances, policymakers decided to activate the general escape clause in the Stability and Growth Pact. The activation of this clause temporarily lifted all restrictions on fiscal policy. This helped prevent undue procyclical fiscal consolidations, such as during the sovereign debt crisis. But shouldn’t an effective and concerted monetary and fiscal policy response also be possible under less dramatic circumstances than the Covid crisis? And wouldn’t we be better off with a framework that allows for more effective macroeconomic stabilization policies without needing to have recourse to an emergency clause that in effect requires the suspension of all fiscal rules? And if the answer to both these questions is yes, how do we ensure that we maintain a balanced macroeconomic policy mix in the EMU, during the current recovery phase and beyond? Based both on theory and past experience, I think that, in order to make our monetary union more stable, we need a fiscal framework that enhances coordination between member states and allows for a better alignment of monetary and fiscal policy over the entire economic cycle. This requires sufficiently countercyclical fiscal policy also from a euro area wide perspective. Not only in bad times or when persistently low interest rates limit the scope for conventional monetary policy. But also in good times, so that governments reduce debt levels to pay for stabilization policies in the future. Repair the roof when the sun is shining, an integral element of countercyclical stabilization policy that often gets overlooked. An enhanced fiscal framework to ensure stability of the EMU As a central banker, it is not up to me to map out in detail how the EMU fiscal framework should be changed. That is a political decision. Nor would I want to give you the impression that I am advocating a complete overhaul of the framework. At the risk of repeating myself: fiscal policy serves many other legitimate objectives, and there are many constraints, especially in a monetary union where fiscal policy is and will remain primarily a responsibility of national governments. So the Stability and Growth Pact continues to serve an important purpose. My argument today is about evolution, not revolution. What I will do is outline three features that I think would help to make the current framework more effective in allowing national fiscal policies to stabilize the economy at the euro area level. And to encourage greater alignment between central bank and government policies. First of all, we need a fiscal framework that would improve coordination of national fiscal policies within the economic and monetary union. The Next Generation EU fund is a big step in the right direction. It expands fiscal space across the union during a downturn and thereby allows the euro area fiscal stance to remain well-aligned to monetary policy. Furthermore, the fund’s expenditures are targeted at the most vulnerable regions and are focused on public investments that will help raise countries’ potential output. The combination of public investment and targeted structural reforms is needed to increase potential growth and make our economic and monetary union more resilient. We have seen, in the past, that growth-enhancing public investments are often first to fall victim to spending cuts. That in itself is a major cost of the current fiscal framework. We still have a lot of work to do to make the Next Generation EU fund a success. But if it becomes a tangible success, it would of course set a precedent, with the promise of more to come. Secondly, next to improving coordination of national fiscal policies, the SGP should be sufficiently flexible to allow for sizable and sustained expansionary fiscal policy, beyond normal automatic stabilization, if economic circumstances so dictate. As we discussed earlier, this is even more important in the current low interest rate environment. The activation of the general escape clause allowed for this flexibility during the early stage of the pandemic. And it may very well be needed in the face of another extreme event in the future. But a suspension of all fiscal rules should not be our only tool to achieve a balanced policy mix to deal with economic shocks. That’s because the emergency clause also has drawbacks. The uncertainty about whether and when the clause is going to be activated makes the framework less predictable, and could discourage governments from engaging in countercyclical spending. Moreover, depending on the circumstances, a complete suspension of the framework could be too much of a good thing, if it hampers fiscal discipline. Finally, both deactivating and reactivating the clause could prove politically difficult. Therefore, flexibility should somehow be a more intrinsic feature of the system, and not one that arises only in emergencies. So the European fiscal framework should allow for more coordination of national fiscal policies and more flexibility to deal with large shocks. In order for these two features to work, we need a third one. A monetary union with multiple budgetary authorities requires sustainable national debt levels. Therefore, an enhanced fiscal framework should have robust and credible rules that make sure national governments keep their debt levels in check. Not only should member states build up sufficient buffers in good times. They should also increase potential economic growth that ultimately generates the debt repayment capacity. Economic life gets so much easier with half a percentage point more productivity growth! In many EU countries there is scope for structural reforms that would give a welcome boost to economic growth. Fiscal policy has an important role to play here by maintaining a sufficient level of public investment. Conclusion Ladies and Gentlemen. We are nearing the end of our journey. We’ve seen that the mix of monetary and fiscal policy matters for their effectiveness in stabilizing the economy. Especially when interest rates are persistently low and central banks have limited scope for manoeuvre. In that case, fiscal policy can play an important role, by raising aggregate demand and inflation. As the current low interest rate environment is likely to persist, we need a structurally larger role for fiscal policy in macroeconomic stabilization for the foreseeable future. This does not replace, but should be assessed in conjunction with other fiscal objectives, such as debt sustainability and income redistribution. The current fiscal framework in the EMU, despite its merits, is not well equipped to deliver that. The European sovereign debt crisis illustrated that very clearly. While the Covid crisis experience was more encouraging, it also revealed that fiscal flexibility is needed and has to be an integral feature of the framework, rather than an all-ornothing button which may, or may not, be pressed in an emergency. But more flexibility will only work if public debt is kept in check and the growth potential of our economy is enhanced. The European economic rulebook will have to be updated to facilitate this. Does that mean that the Stability and Growth Pact, which our predecessors constructed thirty years ago, was bad economics? No, of course not. Against the economic backdrop of that time, it made perfect sense, and many elements continue to do so. But the economic landscape has shifted, and so have our views on macroeconomic policy. Wasn’t it Keynes himself who once said: “When the facts change, I change my mind. What do you do, sir?” Of course, changing the rules takes time. What does that mean for fiscal policy in the meantime? Well, policymakers should continue what they started during the Covid crisis and use the current windfall of low interest rates to address the structural challenges our economies face. That will not only offer us a chance to improve the resilience of our monetary union, but also help to future-proof our economies. Johan Witteveen was very critical of fiscal policy in Europe during the European debt crisis. I would have loved to hear his opinions on our discussion today. He would no doubt have added some profound insights, and probably have alerted us to some shortcomings in our thinking. And I would have liked the idea of him walking through the corridors of the Justus Lipsius building in Brussels, where the European finance ministers meet, to discuss policy issues and share his views. Just as he used to do with my former colleagues at the IMF. Even if that’s no longer possible, his views on fiscal policy seem more alive than ever. Let them be an inspiration for us here, as well as for policymakers elsewhere in Europe, as we rethink the fiscal rules in our Economic and Monetary Union. Thank you | netherlands bank | 2,021 | 6 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the 13th Conference on Payments and Market Infrastructure, jointly organised by the National Bank of North Macedonia and the Netherlands Bank, Ohrid (digitally), 9 December 2021. | Klaas Knot: On payment trends - opportunities and risks Speech by Mr Klaas Knot, President of the Netherlands Bank, at the 13th Conference on Payments and Market Infrastructure, jointly organised by the National Bank of North Macedonia and the Netherlands Bank, Ohrid (digitally), 9 December 2021. * * * Good morning everyone. It is a pleasure to be here at this conference, jointly organised by the National Bank of North Macedonia and De Nederlandsche Bank. I am glad to see that, after a one year hiatus, this thirteenth conference gets to take place again – even though only virtually. Before continuing, I would like to express my shock and sadness at the terrible bus accident that happened two weeks ago – two days before we were originally going to meet. My deepest condolences to the people who have lost family members and beloved ones. Coming back to this conference – today and tomorrow, you will be discussing payments in the digital era, with an inside out perspective. And that perspective is, truly, the perspective of a modern central banker. A central banker who keeps his finger on the pulse of what happens in our society. A central banker who is aware of recent payment trends. A central banker who looks at what is happening nationally, but also globally. Trends regarding, for instance, the use of cash. In the Netherlands, the use of cash has declined steadily. Ten years ago, about 60 percent of all shopping was paid for in cash. Before the pandemic, that number had already dropped to 32 percent. Today, the number of retail cash payments has declined even further – to a little over 20 percent. Like in many countries across the world, also in the Netherlands and in North Macedonia we see an ongoing digitalisation of our societies and payment structures. This global trend has created a lot of opportunities for organisations and their customers. Unfortunately, it has also, among other things, contributed to an increase in cybercrime. Both financial institutions, like banks, and their customers are being targeted by criminals. A compelling example is the rise in ransomware attacks over the last couple of years. Another trend today, is the development of cryptos. Cryptos are issued independently of commercial or central banks, but there are increasing links between cryptos and the mainstream financial system. A serious drawback is the fact that the value of most cryptos is very volatile. This makes them unsuitable as a means of payment, store of value and unit of account. And the accessibility and anonymity of cryptos make them vulnerable to illicit activities. Regarding stablecoins, there are specific concerns. Stablecoins are cryptos whose value is tied – or is at least claimed to be tied – to an outside asset, such as a regular currency or gold. Stablecoins can bring innovations, especially for cross-border payments, like cheap remittances. But they also bring risks, in particular if they would be adopted as a generally accepted means of payment – risks, for instance, regarding the safety, efficiency and integrity of payments systems; or regarding cyber security and operational resilience; or regarding data and consumer protection. And a final big trend I would like to mention, is that, today, financial institutions are increasingly using big data and artificial intelligence as part of their fintech solutions. Just think of a bank’s chatbot. Using AI, this chatbot can tell customers what to do when they lose their bank card or help them with information about taking out a loan. In the field of fintech, North Macedonia has made commendable progress. Recent research on 1/3 BIS central bankers' speeches the feasibility of implementing fintech in North Macedonia, led by the National Bank, concluded that the country would be ready for a fintech-led transformation in the financial services sector.1 A lot, if not all, of these trends and technological innovations, are here to stay. And as central bankers and supervisors, we welcome any technological innovation that has the potential to make payments more convenient and accessible for everyone; the potential to contribute to our societies’ welfare; the potential to contribute to a trustworthy and stable financial system. But – there is a big sine qua non. For us, as supervisors and central bankers, trust goes hand in hand with rules, regulation and supervision. On the one hand, we need to give room to promising technological innovations, but on the other hand we need to keep the risks in check. With too much leeway for risks people might lose trust in the financial system. So, if we look at what is going on today, how are we looking at tomorrow? For many of us, the digital era means a welcome step forward in payment options. Today, for instance, we use our smartphones for much more than just calling and texting. Mobile payment requests, contactless payments, and smartphone and smartwatch payments have become the order of the day. But it would be wrong to assume that this goes for everyone in our society. Regarding the future of cash, at least for the foreseeable future, central banks should make sure that cash remains accessible, available and affordable – for everyone. At De Nederlandsche Bank, we even advise people to carry some cash. For instance in case card networks are down. This could happen due to technical issues, or maybe even a cyberattack. Regarding this latter threat, banks and other financial institutions are investing millions of euros to safeguard the security of online banking and other applications. They also work closely alongside the police and law enforcement. And there is also increased international cooperation in the financial sector. The declining use of cash also raises the question of the future of public money. That is why the ECB, as well as other central banks, are currently investigating a Central Bank Digital Currency, a CBDC, as a new, additional, way to make central bank money available to the public. Without, of course, the intention of crowding out private alternatives. Looking at cryptos and stablecoins, I want to underline the cross-border nature of the cryptospace. Several jurisdictions have started setting up regulation, and it is important that we discuss this at an international level to avoid regulatory arbitrage. Finally, regarding big data and AI, we must ensure that AI does not discriminate against certain groups of consumers; that its processes can always be verified; and that personal data are wellprotected. For this reason, De Nederlandsche Bank works with other supervisory authorities to develop guidelines that prevent discrimination and ensure the processes can always be verified. All the innovations I just discussed are not limited by traditional boundaries. To benefit from them while also effectively curbing their risks, we need both a national and an international approach. All the more reason for conferences like this to exchange views and experiences. I am proud of the constructive and ongoing collaboration between our two central banks. And I want to thank Governor Bezhoska for inviting me to this year’s edition. At the time of the first conference, in 2008, I wasn’t even President of De Nederlandsche Bank yet. But I very well remember the tenth edition, in 2017. I was in Ohrid then, with colleagues of the ECB and delegates from the European Commission. And I have very good memories of that trip. 2/3 BIS central bankers' speeches North Macedonia is a beautiful country. Since its first edition, this conference has only further matured. It has grown both in audience and in breadth of topics. And this year’s program is, once again, testimony to that. I wish you all an inspiring two days. 1 National Bank of the Republic of North Macedonia, accessed on 7 December 2021, RNM Fintech Survey Final Report Clean 211220.pdf (nbrm.mk) 3/3 BIS central bankers' speeches | netherlands bank | 2,021 | 12 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the UBS European Conference, 9 November 2021. | Klaas Knot: The outlook for inflation and monetary policy in the euro area Speech by Mr Klaas Knot, President of the Netherlands Bank, at the UBS European Conference, 9 November 2021. * * * The outlook for Euro Area inflation has clearly improved over the past few months. After years of low inflation, the headline number has passed 4% in October, for the first time in thirteen years. Euro Area inflation came from a lower pre-pandemic level than in the US, so this is a significant change. And in fact, after a prolonged period of deflation risks, the increase in inflationary pressures in the Euro Area is rather welcome. Inflation will stay at current levels at least until the end of this year. My baseline view is that current levels of Euro Area inflation are largely transitory, and that inflation will fall below 2% towards the end of next year. But upside risks to this baseline dominate. And we need to prepare for upside scenarios as well. Let me elaborate a bit on this. There are three factors relevant for inflation in the future: transitory factors that we know will end at a specific date, transitory factors of uncertain length, and factors that affect inflation durably. An important example of the first type is the temporary reduction of the German VAT-rate that ended in January of this year. It will drop from the inflation rate in January next year. This will lower core inflation in the Euro Area significantly from then onward. Another example comes from oil prices, where past increases will filter out of the data after 12 months. Oil prices were quite low one year ago and started rising almost continuously from there. This base effect will have a moderating effect on inflation in the months to come as well. This is the easy part. Less easy are transitory factors of uncertain length. Important in this category are the inflationary pressures from supply chain bottlenecks and future developments in energy prices. They both have a strong but transitory impact on headline inflation. At some point in time, bottlenecks will stabilize or even unwind. And energy prices will stop rising. But these transitory pressures are not necessarily short-lived. In fact, we have come to realize that the inflationary pressures from these sources last longer than initially thought. Thirdly, for our assessment of durable inflation, future wage developments are crucial. The average unemployment rate in the Euro Area is at the same level as before the start of the pandemic and employment has almost returned to the pre-pandemic levels. Nonetheless, wage demands, and realized wage agreements continue to be relatively modest. But if inflationary pressures were to persist longer, while the recovery matures and the labor markets conditions become tighter, higher wage increases will become more likely. If I weigh these three factors, I first note that the inflation outlook is one characterized by elevated uncertainty. Nonetheless, my current assessment is that transitory factors still dominate the inflation picture. The longer these transitory factors persist, however, the higher the probability that elevated inflation eventually feeds into higher wages. That is why our assessment of future wage developments will be very important in the period to come. Focusing on policy implications, the recent increase in inflationary pressures does not mean that we have already achieved our goal of inflation converging durably to our 2% target. Nor does it mean that our accommodative monetary policy is about to come to an end. In fact, our interest rate forward guidance is clear about this: we will only start raising our key policy rates once we are confident that inflation has durably converged to our target, also in our projections. This is a condition that is very unlikely to be fulfilled already in 2022. 1/2 BIS central bankers' speeches Although in the current outlook inflation has not yet durably converged to our 2% target, we should not be complacent about upside risks to inflation. We therefore need to maintain a degree of policy optionality. Or in other words, we cannot make long-lasting unconditional commitments that might end up being incompatible with how the inflation outlook develops. This need for policy optionality has implications for the transition out of the Pandemic Emergency Purchase Program, the PEPP, which is likely to come to an end in March 2022. Here, we face two challenges related to the PEPP’s dual purpose. First, there’s the PEPP’s monetary stance role. The program was designed in part to counter the downward impact of the pandemic on inflation. With the pre-pandemic inflation outlook restored, and with upside inflation risks being prominent, this goal has been reached. A key question going forward is whether we will need a higher purchase volume under our regular Asset Purchase Program to facilitate the transition out of the PEPP and to further support inflation dynamics. To me, this is not clear-cut. While we will definitely aim to prevent cliff effects, it very much depends on the inflation outlook whether we will need a durably higher purchase pace. If this outlook changes, I think the Asset Purchase Program, the APP, is our appropriate instrument of marginal policy adjustment. We should thus maintain the policy optionality to adjust our purchase pace in either direction, if needed.7 A second challenge is that, when we transition from the PEPP to the APP, we will likely lose some of the flexibility that was embedded within PEPP. This flexibility has served us well in countering risks to the monetary policy transmission mechanism caused by the pandemic. PEPP has therefore been designed in such a way that purchases can be conducted in a flexible way over time, across asset classes and among Euro Area countries. When we transition out of PEPP, we will need to assess whether maintaining this type of flexibility is proportional and, if so, how it can best be achieved. I think I stop here and hand it over to you, Axel. 2/2 BIS central bankers' speeches | netherlands bank | 2,021 | 12 |
Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, to the press conference of the Financial Stability Report, 11 October 2021 | Klaas Knot: Introduction to the press conference Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, to the press conference of the Financial Stability Report, 11 October 2021 * * * Welcome to this press conference on the Financial Stability Report (FSR). I would like to start by walking you through the main elements of the report that we have published today. Fortunately, the situation now is very different to how it was when we met at last year’s press conference. Then, we were right in the midst of the second wave of the pandemic. So, I am glad that today, I have the opportunity to see you in person, rather than virtually. There has also been a considerable improvement economically. The economy has recovered strongly from the blow we were dealt by the pandemic. Mainly due to high rates of vaccination, social distancing measures have been phased out, and society has almost been completely reopened. The economic recovery is actually stronger than we expected. The economy has rebounded in a short time, and estimates both in the Netherlands and worldwide have in many cases recently been revised upwards. The fact we went into this crisis with substantial fiscal buffers is largely to thank for the buoyant economic recovery. This enabled the government to absorb the greatest blow, and to support the economy. And thanks to their higher capital buffers, banks have also been able to make a positive contribution. The threat of a resurgence in the pandemic has not disappeared completely. But even in the event of a new wave of infections, I am still reasonably optimistic. The economic impact of new waves will be lessened considerably as the economy has to an increasing extent adapted. Now government support has ended, the right market dynamics have been restored. Although there will undoubtedly be businesses that still run into difficulties, I don’t expect this to lead to a large wave of bankruptcies. The economic recovery is robust, and most businesses are essentially healthy. I’m optimistic about the economic recovery, although I am less positive about the build-up of financial vulnerabilities and risks. Precisely now that the economy is improving, we tend to be less aware of the vulnerabilities building up. And that is something I would like to guard against. In view of this, our Financial Stability Report specifically focuses on four themes: financial markets, the housing market, climate risks and bank buffers. I would like comment on these first two topics. Financial markets First, international financial markets. Since the unrest of March 2020, risky behaviour among investors has increased sharply again. Spurred on by low interest rates, investors are sailing close to the wind and the appetite for risk is high. This is reflected in high price-to-earnings ratios on equity markets, ever-lower risk premiums on risky bonds, and historically high issuance levels of risky corporate debt, which is often also highly leveraged. This risky behaviour is only sustainable at low inflation and interest rates. Increasing inflation is making financial markets jittery, fuelled by fears of a tightening in monetary policy and rising 1/2 BIS central bankers' speeches inflation. And that is precisely what we have been seeing on the stock markets in the past few weeks: sentiment is less exuberant, as inflation is again back on investors’ radar. I also still expect that the inflation shock we are currently witnessing is largely temporary. Nonetheless, from the perspective of healthy risk management, it is also important to take other scenarios into consideration. Also because the 1970s taught us that we do not have an unlimited capacity for envisaging how temporary inflation is. If financial markets fail to take sufficient account of scenarios involving persistently high inflation and its accompanying interest rate environment, it could lead to shock price falls in the future. Housing market On to the Dutch housing market. It won’t have escaped anyone’s attention that house prices have risen even more steeply this year. Over the past five years house prices have on average risen by 8 per cent annually, but we have recently seen nationwide annual rises of over 15 per cent. House prices are also rising faster in the Netherlands than elsewhere in Europe, so this cannot be ascribed solely to low interest rates. There is a persistent shortage on the supply side of the housing market, and additional housing construction efforts are certainly required. However, housing shortages have always existed and will probably never completely disappear in a densely populated and neatly organised country like the Netherlands. The exuberant rise in house prices has more to do with Dutch households’ borrowing capacity. There is quite simply too much money and too few houses. Buyers are stretching the boundaries to place the winning bid, displaying increasingly risky lending behaviour. Particularly first-time home buyers are more often borrowing at the limit relative to their income. It is still possible to finance the full value of a property with a mortgage. Interest-only mortgages are again becoming popular. The many tax advantages available serve to drive up house prices even further, with mortgage interest tax relief the clearest example of this. Schemes that were introduced to give first-time buyers greater opportunities in the housing market are unfortunately mainly having an adverse effect. Altogether, this causes spiralling higher house prices and increasing debt levels. Lending behaviour developments are generating risks for households and financial institutions. Banks, however, do not yet take sufficient account of the systemic risk inherent in the housing market. They are vulnerable to the impact that a price correction on the housing market would have on economic activity, and thus on the quality of their loan portfolios. In order to increase their resilience, we will introduce the previously announced floor for risk weighting of mortgages on 1 January 2022. Final remarks Now the recovery of the Dutch economy is gaining traction, it is important to refocus on structural vulnerabilities. On the housing market, but of course also when it comes to the energy transition and the problem. The formation of a new coalition government offers the perfect opportunity to set out appropriate policies in these areas. This concludes my introductory statement. I would be happy to answer any questions you may have. 2/2 BIS central bankers' speeches | netherlands bank | 2,021 | 12 |
Speech (virtually) by Mr Klaas Knot, President of the Netherlands Bank, at the Forum Analysis, Milan, 8 July 2021. | Klaas Knot: On financing the energy transition Speech (virtually) by Mr Klaas Knot, President of the Netherlands Bank, at the Forum Analysis, Milan, 8 July 2021. * * * It is a pleasure to be back in Milan – even if it is only virtually. About 35 kilometres south of Milan lies the city of Pavia. Twenty years ago, I studied there for a semester – so I have very fond memories of that city. One of the most famous people that ever lived in Pavia is Alessandro Volta. In 1799, he invented the battery. This invention would soon lead to the development of the first electric motor – a machine that, in its current form, plays an important role in the transition to a net-zero society. This transition will be hard to achieve. But it is what we will need to do – because climate change is a major threat to societies and economies all over the world, and to the stability of the entire financial system. Currently, however, we are still far from achieving the ambitions set out in the Paris Climate Agreement. If we want to achieve these ambitions, we will need large-scale investments in sustainable energy services, in agriculture, in manufacturing, and so on. And these investments will need to be accompanied by increased efforts to reduce greenhouse gas emissions. The lion’s share of these investments will have to come from the private sector. But when we look at financing flows, whether in capital markets or bank finance, we see they are mostly directed towards large and often carbon-intensive companies – companies perceived as having low credit risk. The energy transition, however, hinges on successful technological innovations. According to a recent report by the International Energy Agency , and I quote: “most of the global reductions in CO2 emissions between now and 2030 in the net zero pathway come from technologies readily available today. But in 2050, almost half the reductions come from technologies that are currently only at the demonstration or prototype phase.” Early on, these innovative technologies are often less competitive than fossil alternatives. This makes banks more hesitant to finance these higher risk activities. And innovative start-ups are often too small to attract capital market financing. So currently, innovation investment is best aligned with the risk appetite of private equity firms. But they do not have a large presence around the world. So this is where governments come in. The bulk of the much needed investments will indeed have to come from the private sector – but there is a loud and clear sine qua non. And that is that governments create investment conditions that improve the business case for climate investments. They need to do this for both companies in need of green finance and investors providing green finance. If demand and supply grow in the same pace we reduce the risk of a green bubble once the private sector increases its green investments. And to reduce the risk of greenwashing, we need international standards such as a taxonomy. 1/4 BIS central bankers' speeches Our governments’ broad mandates allow them to create favourable conditions for green investments – and so they should act upon it. Meanwhile, of course, central banks should do what they can within their mandates and continue to work on favourable financing conditions. But I want to stress that, given their broader mandate, our governments are the primary actors in greening our economies. I will now elaborate on three ways governments could step up their efforts. After that, I will talk about the role of supervisors and central banks in greening our economies. So first – governments need to address the issue of under-priced carbon emissions. This will improve the business case for climate investments. With the Emissions Trading System, the ETS, European leaders have a powerful tool to do this and achieve the target of reducing net EU greenhouse gas emissions by 55 percent by 2030. Second – investment uncertainty, which is usually high for innovative green investments, needs to be reduced. And governments could contribute to this with a consistent and reliable policy mix of subsidies, co-financing and guarantees. A good example are offshore wind farms in the Netherlands: minimum price guarantees helped the industry scale-up, after which costs fell sharply. The European Commission can stimulate public-private partnerships by simplifying government support rules. They can also do so by granting exemptions for the co-financing of climate investment by governments. Third – corporate reporting of sustainability data must improve, in terms of quality, comparability and consistency. And this credible and comparable information should be readily available for all market participants, shareholders and other stakeholders across the world. That is why I encourage authorities to support the IFRS Foundation in developing a global baseline standard. One that is, first, compatible with regional and national disclosure frameworks that may be more far-reaching; and two, builds upon the recommendations of the Task Force on Climate-related Disclosures. Until the IFRS reporting standards have been developed, it is important we avoid fragmentation. We need to ensure that national and regional requirements currently being put in place, can easily dovetail with the new global standards later on. Let me now talk about what supervisors could do to encourage climate investments. Supervisors expect financial institutions to manage their climate-related risks. This calls for a more forward-looking approach from financial institutions and supervisors – with stress tests and scenario-analyses becoming an integral part of the regular toolkit. And this requires financial institutions to take material sustainability risks into account – which means measuring, assessing and controlling these risks as part of their regular risk management processes. The Dutch financial sector is increasingly aware of climate risks and is taking steps to mitigate them. For example, many financial institutions are working on identifying which carbon-intensive sectors they are exposed to. The Dutch financial sector has also committed to reporting on the climate impact of its financing and investment, and to reduce its impact. 2/4 BIS central bankers' speeches Supervisory authorities, like De Nederlandsche Bank, also need to investigate where and how climate-related risks can be further integrated in the applicable prudential frameworks for banks and other financial institutions. They need to do this to ensure the soundness of financial institutions. Furthermore, climate risks should be adequately reflected in prudential regulations, with adjustments to the framework where necessary. That is why I welcome the work of the European Banking Authority and the Basel Committee in this area. The uncertainties surrounding climate-related risks make them harder to quantify, but this certainly does not mean we can afford to ignore them. Prudential regulation is aimed at ensuring financial institutions can absorb unexpected losses – and this should include losses related to climate change. In our macroprudential supervision, we have designed a climate stress test. And in the future, we aim to integrate climate-related risks in our regular macroprudential supervision. Last but not least, let me now turn to what role central banks can play in greening our economies. The primary objective of the ECB is price stability. And we know that climate change in itself can cause adverse demand and supply shocks, and that these shocks cause higher inflation volatility. Governments’ transition policies may also lead to more inflation volatility. The most effective measure for greening the economy is adequate pricing of carbon emissions. Doing this will lead to relative price changes and the reallocation of resources across sectors. The greater the delay in implementing such government policies, the more abrupt the transition will be. This raises the risk of stranded assets on balance sheets and shock-induced revaluations of financial sector exposures. Whether transition measures are direct or indirect, all the possible, likely, or actual effects of climate change will be reflected in pricing measures. And this affects price stability. So you can easily see that climate change falls within the monetary policy horizon. The secondary objective of the ECB implies that it shall support the general economic policies of the EU, provided it does not interfere with the primary objective. And with the Green Deal, the EU has an ambitious climate agenda. The ECB is considering how best to take account of climate change in its current monetary policy strategy review. In addition to the primary and secondary objective, the ECB needs to integrate risks related to climate change in its own risk management framework. We know that climate-related risks are a source of financial risk. And since we expect financial institutions to manage their climate-related risks, the ECB should lead by example. And finally – central banks should be transparent about the climate risks on their own balance sheets. And they should ensure that their own reserves are aligned with international sustainability goals and Corporate Social Responsibility standards. At De Nederlandsche Bank, we are currently exploring whether we can align the equity portion of our own-account portfolio with the agreements set out in the Paris Climate Agreement. And we will start identifying the physical climate risks of our investment portfolios, such as the impact of increasing drought and extreme weather conditions on our investments. By setting a good example, central banks can advocate transparency on climate risks in financial markets. This is, for instance, why De Nederlandsche Bank added a climate annex to its annual report this year, fully in line with the recommendations of the Task Force on Climate-Related Financial Disclosures, the TCFD. 3/4 BIS central bankers' speeches Dear all, today I have spoken to you about the role that governments, supervisors and central banks can play in greening our economies. But I would like to stress that none of them operate in isolation. Collaboration and coordination between the different stakeholders, including these three parties, but also international organisations like the FSB and the G20, and the financial sector itself, will be paramount in the transition to a net-zero society. Let me conclude. Exactly one hundred years after Alessandro Volta invented the battery, the first car reached a speed of over one hundred kilometres an hour. This was in 1899. It was a Belgian car. And that car was electric. This electric car even had a name. It was called La Jamais Contente. The Never Satisfied in English. Or La Mai Felice in Italian. Regarding the energy transition, we have been satisfied with too little for too long. We need immediate, decisive and greater action. And we need this from everyone – each within their own mandate, everyone contributing their own expertise. All of us, to use a famous ‘Italian’ expression, will need to do ‘whatever it takes’. 4/4 BIS central bankers' speeches | netherlands bank | 2,021 | 12 |
Speech (virtually) by Mr Klaas Knot, President of the Netherlands Bank, at the Euro50 Group meeting "Coping with the legacy of the Covid-19 crisis", Washington, 14 October 2021. | Algemeen nieuws Speech Klaas Knot - Back to the future: euro area inflation outlook is back on track 14 oktober 2021 Algemeen Lees voor (c) @Marieke Bijster/DNB On October 14th, Klaas Knot spoke at the Euro50 Group meeting “Coping with the legacy of the Covid-19 crisis”. First, he reviewed the current inflation outlook as perceived by both market participants and central bankers. Second, he addressed the question how a changing perception of inflation affects financing conditions and how this relates to monetary policy. Knot: “Based on the current outlook, the ECB’s monetary policy intention is to keep rates at their current or lower levels until we see a durable convergence of inflation, also in our forecasts. And this may imply moderate inflation rates above 2% for some time – although I don’t think it would be proportional to use asset purchases to actively strive for such an overshoot. Date: 14 oktober 2021 Speaker: Klaas Knot Location: Washington DC (digitally) Exactly one year ago, on October 14th 2020, the Dutch authorities announced a partial nationwide lockdown. Today, the Netherlands is gradually loosening Covidrelated restrictions. Exactly one year ago, chief U.S. medical advisor Dr. Anthony Fauci, said that people might have to cancel Thanksgiving. Today, the US Center for Disease Control and Prevention offers a list of tips so people can celebrate Thanksgiving safely. From a global economic perspective, the pandemic put forceful downward pressure on both inflation and inflation expectations. But today, and for a few months now, we see rising inflation and inflation expectations. One of the most widely debated topics in financial markets, is how the inflation path will evolve further. When we look at this slide, Figure 1, on the left, shows the ECB’s latest macroeconomic projections for inflation, compared to the pre-crisis inflation path. You can see that the current projections suggest a path for inflation that is close to the pre-pandemic projections from December 2019 – at least for the end of our projection horizon. This is an encouraging development as one of the primary goals of our Pandemic Emergency Purchase Programme – the PEPP – is to counter the downward impact of the pandemic on the path of inflation. If these developments are to continue, I am confident that the pre-pandemic inflation gap in our macroeconomic projections will close by the end of this year. In figure 2, on the right, we see both the ECB’s inflation projections and the marketbased inflation expectations. You can see that both have increased since the beginning of this year, particularly short-term inflation expectations. This means that both the ECB and financial markets expect inflation rates to increase. At least temporarily – due to supply side factors like higher energy prices and supply side bottlenecks. The crucial question is, of course, how transitory these driving factors of inflation are. Or how persistent they might turn out to be – thus leading to durably higher inflation. Of course, our macroeconomic projections are based on a set of assumptions. They serve as a snapshot in time and are inevitably surrounded by uncertainty. That is precisely why the Eurosystem closely and continuously monitors a broad array of inflation indicators – including those from financial markets. This allows for more real-time monitoring, but also helps to assess whether the models fully capture the inflation momentum and persistency. The market view on inflation developments therefore often serves as an important cross-check, both for the baseline scenario and the risks associated with it. Currently, market-based inflation measures are close to multi-year peaks, both in the short and medium term. More specifically, the five-year five-year inflation-linked swap rate, an important market proxy for medium-term inflation expectations, hovers around 1.8% – the highest it has been since 2017. These market-based inflation measures can be broken down into an inflation expectation component and a risk premium component – which is the extra return investors demand to bear inflation risks. Figure 3 shows that both components contribute to the rise in market-based inflation measures. If you look at the area marked in red in the bottom right, you can see that the negative inflation risk premium is vanishing quite rapidly. This means investors are again considering the possibility of higher inflation after a period of low inflation. It also suggests that investors increasingly price-out the risk of deflation. We can translate this to the balance of risks, which is the sum of upside and downside risks to our inflation outlook. For a long time, the balance of risks was tilted to the downside. However, today I will argue that the risks for headline inflation are again tilted to the upside. Downside risks largely pertain to the demand effects of the delta variant of Covid-19. Upside risks, in the short to medium term, are mainly linked to more persistent supply side bottlenecks and stronger domestic wage-price dynamics. Figure 4 shows the option-implied distribution of inflation. The darker-shaded areas show that the likelihood of deflation and low inflation outcomes has markedly declined. At the same time, the probability of inflation exceeding our 2% target over the next 5 years increased notably. So this figure underlines that market participants are taking the possibility of higher inflation more seriously as both observations are in line with rising inflation risk premiums. Overall, market-based inflation expectations are much more centred around the ECB’s 2% symmetric inflation target. I very much welcome these developments. Coming from a prolonged period of setbacks and deflation risks, this is good news. These developments in market perceptions of inflation also have important implications for monetary policy as they affect financing conditions – these are the conditions for people and businesses to finance their investments. For a given nominal interest rate, higher inflation expectations would lead to lower real rates and thus an easing of financing conditions. Generally speaking, higher inflation expectations, however, also translate into higher longer-term nominal interest rates. The net effect on the economically-relevant real rate is thus unclear. In December 2020, the Governing Council pledged to maintain favourable financing conditions. And we would do this by calibrating purchases under the PEPP. This calibration is, of course, a continuous exercise – because favourable financing conditions depend on the changing drivers of nominal interest rates, inflation expectations and the equilibrium rate. Over the summer, for instance, the ECB Governing Council frontloaded some of its purchases under the PEPP. We did this to counter a possible rise of nominal yields partly driven by spillovers from the US, as I outlined in my previous talk at the Euro50 meeting in March this year. By doing this, we ensured that financing conditions did not tighten before the growth and inflation outlook in the euro area was on firmer ground. Recently, the Governing Council has become more confident about the firmness of the European recovery. As price pressures in the euro area increased, we modestly recalibrated the PEPP in September. So to complete the circle. On the first slide I showed you that the pandemic-induced inflation gap is closing. Against this backdrop, a moderate rise in interest rates is consistent with our pledge to maintain favourable financing conditions going forward – that is, as long as higher interest rates are driven by higher growth and inflation expectations. And so, the ECB’s current baseline scenario is consistent with ending the PEPP in March 2022. This does not, however, mean the end of loose monetary policy. Based on the current outlook, the ECB’s monetary policy intention is to keep rates at their current or lower levels until we see a durable convergence of inflation, also in our forecasts. And this may imply moderate inflation rates above 2% for some time – although I don’t think it would be proportional to use asset purchases to actively strive for such an overshoot. However, the Eurosystem’s presence in financial markets will remain substantial with the large reinvestments under both the PEPP and the Asset Purchase Programme – the APP. We will continue to run net asset purchases under the APP for as long as necessary. While we are currently thinking about options to ease the transition out of the PEPP, incoming data should clarify how the risks surrounding our current inflation the PEPP, incoming data should clarify how the risks surrounding our current inflation baseline will play out. Now to wrap up. I talked a lot about the uncertainty underlying the inflation outlook. Today, on October 14th 2021, I can only make an educated guess what the actual inflation will be one year from now, on October 14th 2022. But even when uncertainty is a part of economics – the part that humbles us – central banks will not let this uncertainty undermine trust. Trust in the financial system. Trust in the way out of this crisis. Trust in our trade. Thank you. | netherlands bank | 2,021 | 12 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the G20 meeting of Finance Ministers and Central Bank Governors, Jakarta, 17 February 2022. | Klaas Knot: Navigating change in the global financial system - the role of the Financial Stability Board Speech by Mr Klaas Knot, President of the Netherlands Bank, at the G20 meeting of Finance Ministers and Central Bank Governors, Jakarta, 17 February 2022. * * * Good afternoon. It is great to meet you all here in person, as a hopeful step toward normality. First of all I want to thank Governor Perry Warjiyo for inviting me to speak here today. And I want to thank the Indonesian G20 Presidency for their hospitality and their organization of such a smooth event in the face of a still challenging Covid environment. I feel honored to speak before you as the new Chair of the Financial Stability Board. And I am grateful to my predecessor, Randal K. Quarles, for his leadership in a challenging period. Randy came in when the reform agenda that followed the 2008 crisis was nearing completion. We had just started to look ahead. Then the pandemic hit. He did a fantastic job as FSB Chair in turning the FSB’s focus to the crisis at hand, without losing sight of the need to continue to make progress on longer-term priorities. Along the way, he further strengthened the FSB in its role as the primary coordinating mechanism on financial stability matters. I will continue the work that Randy had already started. Here I realize I have big shoes to fill. Luckily, they are already pointed in the right direction. The past three years have seen a fundamental shift in the work of the FSB, from completing the post-2008 reforms to tackling new challenges for financial stability. Here I think of the crisis management and ongoing coordination during the pandemic, efforts to tackle vulnerabilities in non-bank financial intermediation, work to ensure that digital innovation is safe, and addressing the risks that climate change may create for financial stability. The FSB has coped with this shift effectively, not least thanks to the continued support of its members and the G20. Yet we may have seen only the beginning of the changes that the pandemic, digitalization and climate change are bringing to the financial system, and our economies more widely. Today, I would like to discuss with you my view of the role that the FSB should play to ensure that the financial system can navigate these changes safely, while providing the financing that the real economy needs. The FSB is the centre piece of a multilateral approach to financial stability that until now has proven very effective. This was best demonstrated by the G20 reforms following the great financial crisis. These reforms have served the financial system well during the Covid pandemic. Greater resilience of major banks at the core of the financial system has allowed the system to absorb, rather than amplify, the economic shock. Without the G20 reforms, governments would now have to deal with a crippled banking sector in full deleveraging mode, on top of an economy hit by Covid restrictions. We would have had a crisis within a crisis. In my view, this success is in large part thanks to the G20’s commitment to dealing with global challenges together, and to the FSB’s broad membership, its agility and its engagement with other stakeholders. We will need to fully use these strengths, to which I will return later on, if we want to tackle the new financial stability challenges successfully. So let me now discuss the nature of these challenges and what it means for the work of the FSB in the coming years. A big challenge for policy makers worldwide at this moment is navigating their economies out of the Covid pandemic. Two years after its onset, the economic fall-out of the pandemic appears to be subsiding, and the extraordinary fiscal and monetary support measures that kept economies 1/4 BIS central bankers' speeches afloat are being gradually unwound. But as the economic recovery is proceeding at an uneven pace across regions, this unwinding process is increasingly likely to be asynchronous. This creates the potential for cross-border spill-overs. Moreover, since the onset of the pandemic, both public and private sector debt have increased, while asset prices have grown amid a search for yield. This has made the global financial system more vulnerable to a disorderly tightening of financial conditions — a concern that has been accentuated lately by the return of high inflation. The FSB is monitoring and analysing developments closely and stands ready to facilitate global coordination of financial policies, where necessary, to minimize the risk of a disorderly exit. This is being underpinned by the FSB’s new financial stability surveillance framework. The framework enables us to identify global financial vulnerabilities in a systematic manner. It draws on the collective expertise of the FSB’s broad membership. It places particular emphasis on incorporating multiple perspectives in the identification and assessment of both current and emerging vulnerabilities. At the same time as navigating our economies out of Covid, we need to strengthen resilience in the non-bank financial intermediation, or NBFI, sector. The financial reform agenda after 2008 focused heavily on banks. Greater resilience of major banks at the core of the financial system has allowed the system to absorb, rather than amplify, the economic shock from the pandemic. But as a side-effect, risks in the financial system moved from the banking sector to the non-bank financial sector. This is what I have previously referred to as the ‘waterbed effect’. Pressing down on one end of the financial system causes risks to pop up elsewhere. And, indeed, since 2008 NBFI has grown much faster than bank intermediation. It now accounts for about half of all financial assets worldwide. So, we now have some catching up to do when it comes to reducing systemic risk in non-bank financial markets. This is a top priority for the FSB, as reflected in our ambitious NBFI work programme. The pandemic has brought into even sharper focus the central role of digital innovation. Digital innovation offers important opportunities for more efficient and inclusive finance. Let’s take the FSB’s work to enhance cross-border payments. The use of new technology is an important element here. The aim of this initiative is to bring about cheaper, faster and more transparent and inclusive cross-border payment services for the benefit of citizens and businesses worldwide. Over the past year, in cooperation with CPMI, we have done the foundational work under the G20 Roadmap for Enhancing Cross-Border Payments and we have established quantitative targets. Which means we can now go to the next stage: developing specific proposals for material improvements to existing systems and arrangements, as well as the development of new systems. But digital innovation also creates risks. The issues raised by digital innovation in finance are in a number of respects similar to those of traditional NBFI: we need to assess the implications of changes in intermediation structures for financial stability. The key difference is that important innovation is happening outside the traditional financial system, often supplied by non-financial entities such as BigTechs, traded on unregulated platforms and transferred on ordinary computer networks globally. Crypto-asset markets are a case in point. The FSB has been monitoring crypto-asset developments since 2018. Our most recent risk assessment shows that markets for cryptoassets are fast evolving and could reach a point where they represent a threat to global financial stability. I must say I have my concerns about this development. Let’s take for example all the misnomers that are doing the rounds. Unbacked crypto assets suggest all others are backed, which they are not. Most stablecoins are neither stable nor coins. Decentralized finance is often quite centralized. This leads to misconceptions about crypto-assets, which contribute to their fast growth. The FSB is stepping up to the plate to deliver an effective regulatory approach to crypto-assets. 2/4 BIS central bankers' speeches We have issued a set of high-level recommendations for the regulation, supervision and oversight of so-called “global stablecoins”. Also we are continuing to work with the standardsetting bodies to review their implementation and whether any changes are needed. Parallel to this, the FSB has started to examine, together with the relevant standard-setting bodies, regulatory and supervisory issues and approaches to address risks stemming from the so-called “unbacked” crypto-assets. And we will analyse the financial stability implications of Decentralized Finance, in order to understand the need for policy action in that area. Another feature of digital innovation is the ever-greater use by financial institutions of outsourcing to third-party service providers. While outsourcing may have provided additional resilience during the pandemic, it has also reinforced the importance of effective policies for the oversight of financial institutions’ reliance on critical service providers. To this can be added the greater exposure to cyber risk. Greater interconnections in the financial system increase the surface for cyberattacks, which have escalated during the Covid pandemic. Enhancing operational and cyber resilience will therefore remain important items on the FSB agenda. Next to digitalization, we face the ever-growing threat of climate change. While emanating outside the financial sector, climate change may severely affect financial stability. The financial risks of climate change reflect its particular nature: it is global in its causes and its implications, and it is pervasive, affecting all kinds of financial assets and contracts. For safeguarding financial stability and ensuring the financing needed for the transition to net zero, it is key that climate related financial risk is adequately priced in financial contracts. This is crucial because financial contracts price the future, and that future is about to undergo fundamental change. The FSB’s roadmap for addressing climate-related financial risks, which is being taken forward in close conjunction with the NGFS and many other international bodies, aims to ensure that climate risks are properly reflected in all financial decisions. It covers disclosures, data, vulnerability analysis, and regulatory and supervisory approaches. This is important because, as we all know, what gets measured, gets managed. Despite the progress made, the challenges are formidable. They range from identifying and collecting the information needed to measure and assess climate-related risks, to designing robust supervisory tools, such as climate stress tests and scenario analysis. Because there are no international standards in place yet, not least relating to disclosures, we have an enormous opportunity to get this right from the start. We should not miss it. The changes I discussed – the move to a post-covid world, ensuring safe digital innovation, and transitioning to net-zero emissions – are global in nature, including their impact on the financial system. In order to promote global financial resilience and the smooth provision of finance to the real economy in the face of these changes, we need to continue our successful global cooperation. The FSB is uniquely placed to facilitate this, because of its three key strengths. First of all its broad, diverse and multi-disciplinary membership. The FSB brings together in a collegial spirit of mutual trust senior officials from 71 authorities in 25 jurisdictions, and 10 multilateral institutions, covering multiple mandates across different sectors. This broad membership enables the FSB to take a truly holistic – cross-sectoral and international – perspective on financial stability issues. Such a perspective is key to understanding and tackling risks from digital innovation and climate change, which affect all parts of the financial system, as well as understanding system-wide risk in complex financial ecosystems like NBFI. It is also key to avoid regulatory arbitrage and fragmentation. And its broad membership, including the sectoral standard setters, puts the FSB in a position to coordinate effectively. The second strength is the FSB’s agility in addressing near-term threats as well as structural changes in the financial system, while keeping sufficient headroom to be able to respond to new emerging vulnerabilities that are detected. This agility was demonstrated at the start of the pandemic, when FSB members exchanged information on market developments and policy 3/4 BIS central bankers' speeches actions on a daily basis and reprioritized their work and resources to focus on the pandemic. The third strength is the FSB’s engagement, as part of the policy-making process, with a broad range of stakeholders both inside and, importantly, outside the financial sector. The FSB reaches beyond its membership to include over 70 further jurisdictions through its Regional Consultative Groups. This engagement is underpinned by its commitment to transparency as well as its accountability to its various stakeholders, including the G20. This outreach will be even more important in the areas of digital innovation and climate change, where relevant expertise and responsibilities may not rest with financial authorities. I will build upon and further develop these strength during my tenure. I aim to ensure that the FSB remains a member-led and inclusive organization. Because this has proven key for continued support to a multilateral approach. An approach that has proven to work. And I would like to thank you, G20 colleagues, for entrusting me the task of chairing this organization. I look forward to working with you and with my fellow FSB members to ensure that the FSB plays its part in supporting the G20 objective of strong, sustainable, balanced and inclusive growth. 4/4 BIS central bankers' speeches | netherlands bank | 2,022 | 2 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the FINSYS commemoration of Professor Benno Joseph Ndulu on "Realizing a Cross-Border Payment Vision for the Advancement of the African Continental Free Trade Area (AfCFTA)", virtual, 22 February 2022. | Klaas Knot: The road ahead - lifting barriers for cross-border payments Speech by Mr Klaas Knot, President of the Netherlands Bank, at the FINSYS commemoration of Professor Benno Joseph Ndulu on “Realizing a Cross-Border Payment Vision for the Advancement of the African Continental Free Trade Area (AfCFTA)”, virtual, 22 February 2022. * * * Hello everyone. It is an honor to be here – in memory of professor Ndulu. Thank you Doctor Kasekende for reminding us of the importance of Professor Ndulu’s work. He had a vision I can very much relate to – especially in my capacity as chair of the Financial Stability Board. Professor Ndulu’s vision was to establish a cross-border payments system in this region. And this aligns very well with the FSB’s vision. We have made it a priority to enhance cross-border payments – in our case at a global level. So it is a great pleasure to talk to you today about our ambitious workplan. I remember the time when I studied abroad. This was pre-euro. In Italy. And it was quite a hassle for my parents to send me any money. Today, my children are still in high school. But in the future, they may study abroad too. If that happens in the eurozone, I will experience hardly any hassle sending them money. Unfortunately, there are still many payment corridors all over the world which face incredibly high costs and considerable delays. A recent report by the World Bank provides an example from East Africa where, in 2021, the fee for sending 200 dollars in remittances from Tanzania to neighboring Uganda was 23 percent for a Ugandan migrant.1 I cannot begin to imagine giving up nearly a quarter of my income every month just to send that money home to my family. But barriers like these are the reality for many people. And it is not just the cost of cross-border payments. These type of payments are often also slow and not transparent – and then there’s the fact that they are not fully accessible for all. The FSB stance is that the payments barriers should be reduced – for both individuals and companies. The more we trade and invest with one another, the more need for cross-border payments – it is as simple as that. As goods and capital markets continue to internationalise, cross-border payments, more than ever, sit at the heart of global economic activity. Just over a year ago trading officially commenced under the African Continental Free Trade Area. One factor that could greatly enhance the economic benefits of free trade in Africa is cheaper and faster cross-border payment services within the continent and beyond. A lot of what we do daily involves crossing borders. From sending an email to someone abroad, to meeting with you virtually right now. It is time that our money also flows more easily across borders. There are four key barriers to cross-border payments – the cost, the speed, the transparency and the inclusion. To address these four barriers, the FSB has developed a Roadmap to 1/4 BIS central bankers' speeches enhance cross-border payments. We have done this together with our partners, most notably the Committee on Payments and Market Infrastructures. And this Roadmap has been endorsed by G20 Leaders, giving it strong political backing from the largest financial centres. This Roadmap covers the whole payments market – both wholesale and retail payments. And it includes a particular focus on remittances, recognising that they are a critical source of financing for people in developing countries and that they play an important role in economic growth. The Roadmap seeks to deliver the necessary improvements through five focus areas, with cooperation between all stakeholders – public or private, national or international – being essential. Let me briefly walk you through the focus areas. First – part of the success of this Roadmap will depend on public-private cooperation. We will need central banks to improve their core payment systems, allowing the private sector to follow suit. And at the same time, we will need the private sector to play a big role in the needed improvements when developing new payment systems and arrangements, or when enhancing existing services. We will also need the combined efforts of many different types of experts – from payment service providers and system operators, to supervisors, regulators, and central banks. But also from experts outside of the financial sector – like data authorities contributing to streamlining data provision and data sharing. Second – to improve cross-border payments, we need coordination of regulatory, supervisory and oversight frameworks. Cross-border payments obviously involve at least two jurisdictions, and often more, when correspondent banking networks are involved. This often creates frictions – with, as a result, the four challenges I just mentioned. To address these frictions, we will need actions on both an international and a national level. This should lead to a better alignment of regulatory, supervisory and oversight frameworks across jurisdictions. Where appropriate, this should be done on a “same business, same risk, same rules” basis. High-quality customer due diligence is, of course, essential. But it is relatively costly for crossborder transactions. So the FSB wants to improve confidence between financial institutions and between jurisdictions. We want to do this by: promoting more consistent application of AML/CFT standards; facilitating cross-border data flows and information sharing; fostering improved digital identity frameworks as well as customer due diligence infrastructures; and, in specific cases, by identifying low-risk “safe payment corridors”. Our third focus area is that we need to better align existing payment infrastructures and arrangements. The reason for this being that technical differences increase costs and slow transactions. So this third focus area of the FSB Roadmap would seek several things – for example, to strengthen links between payment systems and reduce settlement risk, through measures such as facilitating payment-versus-payment, to improve access by banks, non-banks and payment infrastructures to systems, to extend and align operating hours between systems, 2/4 BIS central bankers' speeches to pursue better interlinking of payment systems for cross-border payments, and to explore reciprocal liquidity arrangements. Fourth – to reduce costs and improve the scope for straight-through data processing, we need better data. To achieve this, we need to adopt common data formats, including rules for conversion and mapping from legacy formats, as well as protocols for information exchange. More specifically, the FSB Roadmap aims to harmonise technical standards common message formats and standards for data exchange. We are also examining the scope for a unique global identifier that links to the account information in payment transactions. These improvements would also be important building blocks to enable the development of efficient new payment infrastructures. Our fifth and final focus area is that we need to examine the potential role of new types of payment infrastructures and arrangements, like central bank digital currencies and well-regulated “global stablecoins”. So far, these innovations have not been implemented broadly – some are still in their design phase and others remain theoretical. But they could, potentially, bypass barriers that are hard to address by merely adjusting existing processes. So with this focus area, the Roadmap is examining in particular to what extent such innovations could contribute to improved cross-border payments – all of this, of course, without compromising on minimum supervisory and regulatory standards to control risks or endangering monetary and financial stability. The importance of this work has recently been emphasised by the rapid evolution and growing popularity of crypto-assets. This has prompted us to accelerate work to strengthen the regulation and supervision of crypto-asset markets. But there is a cautionary tale here. The demand for crypto-assets in part reflects public dissatisfaction with current payment services, and if we do not improve the performance of the regulated market then there may be increasing demand for the less-regulated crypto-asset market to fill the gap. Enabling easier remittance payments, while maintaining their safety and security, will be a key part of this. These are, in a nutshell, the five focus areas of the FSB Roadmap. In some ways, however, the work we have done so far has been the easy part. The hard part lies ahead, as we start to translate our goals into actions. To guide our actions, we have developed a set of quantitative targets. Each target relates directly to one of the four challenges we want to tackle. For example, related to the high cost of cross-border payments, our target is to lower the global average cost of cross-border retail payments to one percent of the amount transferred, with no cross-country corridor above three percent. We have also reaffirmed the UN Sustainable Development Goal targets for costs of sending remittances. In terms of speed, we have set the goal that, for 75 percent of payments, recipients receive their funds within one hour of payment initiation, and the remainder within one business day. In terms of transparency, we want people making cross-border payments to have access to a minimum list of information about their payment – such as on charges and the ability to track the status of their payment. 3/4 BIS central bankers' speeches And regarding inclusion, all should have access to at least one option for sending and receiving electronic payments, and – if possible – multiple options. We are aiming to achieve most of our targets by the end of 2027. This may seem like a long timeframe, but it is, in fact, quite ambitious when you consider the time needed to upgrade underlying infrastructure. Critically, the targets have been set in order to lead to – and motivate – actions that are focused on achieving visible improvements for those making and receiving payments. So after the groundwork of the past two years, we have started, this year, to develop specific proposals for material improvements to existing payments systems and arrangements, as well as the development of new systems. Without these improvements, our targets will not be achieved. And cross-border payments will remain costly, slow, and untransparent, and continue to exclude many of the most vulnerable. To wrap up: Enhancing cross-border payments is a shared global goal. Commitment, coordination and accountability will be critical to its success. The FSB Roadmap gives us the opportunity to make a real difference to individuals, businesses and financial institutions across the globe. Cheaper, faster, more transparent and more inclusive cross-border payments have widespread benefits for companies conducting cross-border business, for tourists visiting other countries or for migrants sending money home to their families. One of the regions that could benefit the most from achieving the global targets is Sub-Saharan Africa, where the challenges of costs, speed and inclusion are greatest. So as we move forward with the Roadmap, we will seek input from emerging markets and developing economies beyond the twenty-four countries in our membership. We will bring in these perspectives via our six Regional Consultative Groups, including our Group for SubSaharan Africa. This group is co-chaired by Governor Addison of Ghana and Governor Kganyago of South Africa, who is also co-chairing the FSB’s coordination group for the Roadmap as a whole. What you are trying to achieve, building on professor Ndulu’s legacy, deserves nothing but admiration. And I hope the FSB Roadmap offers inspiration and encouragement in the tasks you have taken upon yourselves. Maybe one day, one of my children will go and study in Africa. And if they stand in a book store, ready to buy something they need for class, and they text me for some extra funds, I hope I will be able to do that with a simple click on a button. And with me, many others. Thank you. 1 Knomad & World Bank Group (2021). Recovery – COVID-19 Crisis Through a Migration Lens (Migration and Development Brief 35). www.knomad.org/sites/default/files/2021-11/Migration_Brief%2035_1.pdf (Accessed on 18 February 2022). 4/4 BIS central bankers' speeches | netherlands bank | 2,022 | 2 |
Speech by Mr Klaas Knot, President of the Netherlands Bank and Chair of the Financial Stability Board, at the EUROFI High Level Seminar 2022, Paris, 25 February 2022. | Klaas Knot: A global Europe to meet global financial stability challenges Speech by Mr Klaas Knot, President of the Netherlands Bank, at the EUROFI High Level Seminar 2022, Paris, 25 February 2022. * * * Thank you Didier, it is great to be back. As you indicated in your kind introduction, this time I am speaking here in my capacity as Chair of the Financial Stability Board, although with a nod to my other hat, as President of De Nederlandsche Bank. But whether you stand on top of the BIS tower in Basel – where the FSB is housed -, the Eurotower in Frankfurt, or the Toorop building in Amsterdam, the view is not fundamentally different. In fact, many financial stability risks we face today are not only common across Europe, but are global in nature. And these global issues require global cooperation, which is why they are at the top of the FSB’s agenda. Today I want to talk about these global issues, what the FSB is doing, and how Europe can play its part. I will be discussing these issues against the backdrop triggered by the Russian invasion of Ukraine. Developments keep evolving as I am speaking, and I do not want to engage in any speculation about what might happen. But we need to be alert that the dramatic shift in the geopolitical landscape may also affect the functioning and resilience of the global financial system. One of the first priorities for policy makers worldwide is to navigate their economies out of the Covid pandemic. The economic fall-out of the pandemic seems to be subsiding, and the extraordinary fiscal and monetary support measures that kept economies afloat are being gradually unwound. But, as the economic recovery is proceeding at an uneven pace across regions, this unwinding process is increasingly likely to be asynchronous. This creates the potential for cross-border spillovers. Moreover, since the onset of the pandemic, both public and private sector debt have increased, while asset valuations have grown amid a continued search for yield. This has made the global financial system more vulnerable to a disorderly tightening of financial conditions. A concern that has been accentuated lately by the return of high inflation. The job of the FSB here is to monitor and analyze developments closely and facilitate global coordination of policies, where necessary, to minimize the risk of a disorderly exit. At the same time as we need to chart a course out of the pandemic, we need to strengthen resilience in the non-bank financial intermediation, or NBFI, sector. A sector that now represents almost half of global financial assets and is evolving rapidly. Enhancing NBFI resilience offers significant benefits, not least during the transition to a post-Covid world. First and foremost, it will contribute to a more stable provision of financing to the economy. Second, it will enhance the ability of the financial system to absorb different types of shocks. And a resilient NBFI sector reduces the need for the types of extraordinary central bank interventions we witnessed in March 2020. The FSB is therefore working on vulnerabilities in specific NBFI areas. This includes money market funds, where we have developed policy proposals to enhance their resilience. And it includes open-ended funds, where we are working with IOSCO to assess whether recommendations to address structural vulnerabilities are effective. We will use the insights to develop a systemic approach to NBFI risks and policies to address them. We also need to remain vigilant to new threats to the financial system, particularly those that will have a transformational impact on our economies such as digitalization and climate change. Digital innovation offers opportunities for more efficient and inclusive finance, for example in global payments, but it also creates potential new risks. In particular, markets for crypto-assets are fast evolving and could reach a point where they represent a threat to global financial stability. It is critical that we address risks in crypto-asset markets holistically and avoid fragmented policy 1/4 BIS central bankers' speeches approaches that could give rise to regulatory gaps and arbitrage. The FSB is stepping up to the plate to deliver effective and risk-based regulatory approaches for all types of crypto-assets. We are doing so in close cooperation with standard setting bodies and national authorities. These approaches include reviewing the High-level Recommendation for the regulation, supervision and oversight of stablecoins, undertaking further work on so-called unbacked crypto assets, and analyzing the financial stability implications of the rapidly evolving decentralized finance. Another feature of digital innovation is the ever-greater use by financial institutions of outsourcing to third-party service providers. While this may have provided additional resilience during the pandemic, it has also reinforced the importance of effective policies for the oversight of financial institutions’ reliance on critical service providers. To this can be added the greater exposure to cyber risk. Greater interconnections in the financial system increase the surface for cyber attacks, which have escalated during the Covid pandemic. Enhancing operational and cyber resilience will therefore remain an important item on the FSB agenda. Next to digitalization, we face the ever-present challenge to address risks to financial stability from climate change. These risks reflect the particular nature of climate change: it is global in its causes and its implications, and it is pervasive, affecting all kinds of financial assets and contracts. If we want to safeguard financial stability and ensure the financing needed for the transition to net zero, it is key that climate related financial risks are adequately priced in financial contracts. This is crucial because financial contracts price the future, and that future is about to undergo fundamental change. The FSB’s roadmap for addressing climate-related financial risks aims to ensure that climate risks are properly reflected in all financial decisions. It covers disclosures, data, vulnerability analysis, and regulatory and supervisory approaches. Because there are no international standards in place yet, not least relating to disclosures, we have an enormous opportunity to get this right from the start. We should not miss it. It is important to act early to address these big transformational issues in the global financial system. Experience has taught us that global financial stability risks, like so many other global issues, are often best dealt with using a globally consistent approach. Not because one size fits all, but because this makes national policies more effective, provided that the global approach leaves room to be tailored to country-specific circumstances when it comes to implementation. Because of their history, to us Europeans, this is second nature. From the Treaty of Rome to the Treaty of Maastricht, now 30 years ago, the process of European integration has always been about Europeans working together to pursue common interests. That’s why we have always been a strong partner in fostering international cooperation and high-quality minimum standards. Indeed, European countries have been key contributors to the international financial architecture. From the Bretton Woods Agreement back in 1944 to the establishment of the Financial Stability Board in 2009. When it comes to financial stability, the EU itself, but also other countries in Europe, has benefitted greatly from its commitment to multilateralism. The centre pieces of the European financial regulatory framework as we know it today are based on the G20 reform agenda that followed the financial crisis of 2008. These reforms have served the European financial systems well during the Covid pandemic. Greater resilience of major banks at the core of the financial system has allowed the system to absorb, rather than amplify, the economic shock. And in turn, this helped European economies weather the storm. As we have seen, today Europe and the world need each other more than ever in keeping the financial system stable and safe. Focusing on the EU, how can it contribute to making this global agenda a success? First of all, the EU can play an active role in implementing the lessons learnt from the recent crisis. The immediate challenge is to facilitate an orderly exit from the different support measures 2/4 BIS central bankers' speeches without creating shock effects or scarring the economy. Also, any exit strategy will have to bear in mind the risk of spillovers to other countries from uncoordinated actions. Next, the EU should aim to lead by example by implementing reforms in a comprehensive and consistent manner. In particular, the EU could make further progress in implementing the Basel III standards in accordance with the internationally agreed framework. In addition, policy makers need to strengthen the regulation of non-bank financial intermediation. For an internationally consistent approach, it is important that the FSB’s recommendations on money market fund reforms are taken on board in the upcoming review of the EU’s Money Market Funds Regulation. Moreover, the Covid pandemic has once again highlighted the unfinished agenda of increasing the growth potential across Europe, completing the European banking union and the need to break the interconnectedness between governments, the domestic banking sector and nonfinancial corporates. Additional measures are needed to develop the European Capital Markets Union and facilitate private risk-sharing. Finally, the EU can play a leading role in supporting the transformation of the financial system. With the Sustainable Finance Strategy, Europe is leading the way, for example with the development of a green taxonomy and incorporating climate risks into prudential regulation and stress testing. When it comes to meeting the challenges of rapid digitalization, the EU is making important progress on regulating crypto-asset markets, and creating financial oversight of critical third-party service providers. Europe’s hands-on experiences with these initiatives can provide valuable input for the global discussions. The financial system has proven more resilient in light of the pandemic. This has illustrated the benefits of our collective, global reform efforts. The FSB has set out an ambitious work program to deal with the structural challenges of this age. The EU is already taking these challenges head on. This makes me optimistic. We are working towards the same objective. In the road towards that objective, we should make sure that everyone is on board. This means we need European policies that fix European problems and can serve as an example for others, but that are also compatible with a coordinated global response. This is not only good for the world, it is also good for Europe. Because European ambitions can only succeed if they are part of a larger, global effort. Perhaps no one understood this better than Jean Monnet, a great Frenchman and a great European of the 20th century. Of course we all know Jean Monnet as one of the founding fathers of what would become the European Union. But what is less known is that he was also quite a global guy. Even at a young age, he had traveled the world to explore new markets for his family’s cognac business. During the First World War, he worked closely with the Americans to coordinate the food supply of the allied troops in France. During the Second World War, he served in Washington as a liaison between the British and American governments on economic support to the UK. He was one of the architects of the land-lease act and of President Roosevelt’s famous ‘Arsenal-for-democracy’ speech. Right after the war, he realized that any plans for European cooperation would only work if they were compatible with American ideas, thus securing the much-needed Marshall aid. So Monnet’s later vision of Europe was very much based on what he had learned on the world stage during the decades before. That same spirit of Jean Monnet is needed today. The spirit of a global Europe. The spirit that 3/4 BIS central bankers' speeches brought forth not only the Treaty of Rome, and the Treaty of Maastricht, but also the Bretton Woods Agreement, and the post-crisis G20 reforms. Just as we Europeans chose to cooperate to pursue common interests, we need to cooperate at the global level too, to keep our financial systems safe and sound and fit for purpose in the 21st century. 4/4 BIS central bankers' speeches | netherlands bank | 2,022 | 2 |
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Speech by Ms Nicole Stolk, Member of the Executive Board of the Netherlands Bank, at the Data Science Conference of the DNB Data Science Hub, Amsterdam, 12 May 2022. | ()!!.JÿL/.-M!ÿ(-M*ÿNÿOJ!ÿP-Q+0!Rÿ-S+TUÿ TNT+/V!0ÿ-+W0/U/-0 01ÿ345ÿ674483ÿ9ÿ34ÿ99ÿ84184ÿ1454184ÿÿ34ÿÿ99ÿ84184ÿÿ84ÿ 954664ÿ64459ÿ75481 16ÿ5ÿ41ÿ9ÿ99541ÿ591691 !"ÿ#$ÿ%9&ÿ$'$$ÿ ()!*!+"ÿ84ÿ ÿ ,-./-0"ÿ99ÿ84184ÿ1454184ÿÿ34ÿÿ99ÿ84184ÿ 495ÿ79587916ÿÿ1511ÿÿ %&ÿ1914ÿ6ÿ84ÿ ÿ26ÿ14ÿÿ34ÿ34484ÿ95ÿ%41456ÿÿ4ÿ445916834ÿ91ÿÿ6 1&ÿ749654ÿÿ54814ÿ&ÿÿ2164591ÿ91ÿ1ÿ795895ÿÿ36ÿ81454184ÿ63464ÿ5ÿ9&6 &ÿ5ÿ4ÿ68661ÿ145ÿ1436ÿ145ÿ99ÿ5ÿ811916ÿÿ34ÿ5ÿ74ÿ394ÿ33ÿ3746 91ÿ44ÿ36ÿ6ÿ91ÿ17591ÿ91ÿ5ÿ6848ÿ636ÿ6ÿ53&ÿ0ÿ91ÿ3454ÿ9&ÿ91ÿ53&ÿ1&ÿ45 34484ÿ95ÿ%4145ÿ 441ÿ%985ÿ5ÿ445ÿ36ÿ4&14ÿ674483ÿ1555ÿÿ %4ÿ41ÿ3454ÿ46ÿ4&1ÿ86ÿ4451ÿ9ÿ45ÿ69195ÿ541956ÿ4811ÿ9ÿ99541 591691ÿ8911ÿ4ÿ98344ÿ4513ÿ0ÿ6ÿ9ÿ8514&ÿ91ÿ0ÿ394ÿ441ÿ5941ÿ5 3ÿ&ÿ5 94ÿ614ÿ14ÿ0ÿ91ÿ1ÿ9ÿ99ÿ68416ÿ1&64ÿÿ0ÿÿ644ÿ34ÿ7419ÿ94ÿÿ961ÿ5 78&ÿ48616ÿ91ÿ674561ÿ154ÿ51&ÿ1ÿ99541ÿ919&646ÿÿ36ÿ94ÿ891ÿ1&ÿ4 54964ÿÿ54ÿ954ÿ81594ÿ5 3ÿ61ÿ99ÿ684184ÿ1ÿ5ÿ9&ÿ55ÿ:95ÿÿ36ÿ64164ÿ 815ÿ5ÿ814ÿÿ54ÿ891ÿ83914ÿ34ÿ59&ÿ54ÿ55ÿ636ÿ146ÿ9ÿ1954ÿ854ÿ83914 5383ÿ8ÿ4ÿ34ÿ78ÿ5ÿ34ÿ144ÿ81454184ÿÿÿ ;51ÿ9ÿ19194141ÿ74567484ÿ0ÿ91ÿ1&ÿ81594ÿ54&1ÿ1ÿ99541ÿ78&191ÿÿ 6ÿ1457114ÿ&ÿ6ÿ99ÿ4519184ÿ0ÿ63ÿ4ÿ8495ÿ53ÿ516ÿ34ÿ99ÿ539ÿ6ÿ99&ÿ6 53454ÿÿ6ÿ654ÿ91ÿ53ÿ891ÿ988466ÿÿ5ÿ539ÿ75764ÿ<15194&ÿ99ÿ4519184ÿ6ÿ1 1495&ÿ96ÿ644&ÿ96ÿ99ÿ684184ÿ0ÿ1=ÿ15ÿÿ&ÿ394ÿ445ÿ4ÿ5 3ÿ3456ÿ>ÿ19&4ÿ96ÿ9 641?ÿ>ÿ341ÿ&ÿ15ÿ35ÿ36ÿ45ÿ53ÿ63ÿ447ÿ81119ÿ95496ÿ8491ÿ891ÿ51ÿ& 99ÿ4519184ÿ6ÿ1ÿ4541ÿ0ÿÿ6ÿ54ÿ59164ÿ91ÿ75745&ÿ1741414ÿ445&14ÿ891 916ÿ45466&ÿ64ÿ34ÿ97757594ÿ99@ÿ5145637ÿ91ÿ99ÿ1494ÿ6ÿ8495ÿ91ÿ6456ÿ15 539ÿ891ÿ91ÿ8911ÿ4ÿ14ÿ5 3ÿ34ÿ99ÿ5445ÿÿ4519184ÿ6ÿ1ÿ75745&ÿ1741414ÿA 6341ÿ99ÿ51456ÿ8ÿ988466ÿ91ÿ635ÿ546716&ÿ196Bÿ7598&ÿ6ÿ94ÿ91ÿ34 6914ÿ5ÿ5564ÿ916ÿ34ÿ6914ÿ99ÿ6956ÿC1Bÿ1ÿ191&ÿ79846ÿ0ÿ36ÿ6ÿ539ÿ3977416ÿ0ÿ5 4ÿ45&ÿ181594ÿ561ÿ34ÿ919&646ÿÿ 6ÿ984ÿ6646ÿ4ÿ3464ÿ54ÿ1 94ÿ9ÿ9154ÿ7559114ÿ894ÿD%96451ÿ99Eÿ1ÿ$'#Fÿ0 83954ÿ36ÿ45ÿ91ÿ54ÿ194ÿÿ755466ÿ1ÿ64459ÿ516"ÿ5ÿ169184ÿ54ÿ469634ÿ34 818476ÿÿ99ÿ5145637@ÿ445&ÿ99ÿ64ÿ63ÿ394ÿ9ÿ614ÿ5145ÿ74ÿ554ÿ1ÿ51ÿ546 5ÿ988466ÿ74ÿ64ÿ7ÿ9ÿ8994ÿÿ9994ÿ99646ÿ91ÿ345ÿ51456ÿGÿ759&ÿ394ÿ6441 6195ÿ758486ÿ1ÿ&5ÿ16 16ÿ6ÿ&ÿ5ÿ15ÿ39ÿ36ÿ6ÿ9ÿ817894ÿ664ÿ5541&ÿ54 394ÿ9ÿD 99ÿ95Eÿ5383ÿ6ÿ688466&ÿ7631ÿ36ÿ9419ÿ5345ÿÿ H41ÿ34ÿ541416ÿ991946ÿÿ1741411ÿ5ÿ449174ÿ34ÿ496ÿ&ÿ754641ÿ1ÿ&5 797456ÿ14ÿ5ÿ44748ÿ34ÿ54954ÿ4519184ÿ17541416ÿÿ4ÿ1741414ÿ95&ÿ98& G4ÿ17414191ÿ891ÿ4ÿ9ÿ58&ÿ59ÿÿ73&ÿ6ÿ39?ÿ74ÿ49&ÿ99ÿ51456ÿ5&ÿÿ418594 34ÿ64ÿÿ99ÿ96ÿ54&ÿ96ÿ7664ÿ5 31ÿ34ÿ5465816ÿÿ8564ÿ39ÿ814ÿ5 3ÿ99ÿ39ÿ6 41ÿ81419ÿI1&ÿÿ99ÿ954ÿ989&ÿ64ÿ891ÿ34ÿ>ÿ41ÿ61891ÿ>ÿ866ÿÿ8481 341ÿ4ÿ864ÿ5445ÿ34ÿ184146ÿ5ÿ99ÿ51456ÿ954ÿ41ÿ144ÿ251ÿ545ÿ988466 13ÿ85494ÿ94ÿ5383ÿ6ÿ9ÿÿ31ÿ5ÿ34ÿ591691ÿ96ÿ9ÿ534ÿÿ41ÿ4146ÿ98854 ÿ3456ÿ391ÿ34ÿ99ÿ5145ÿ7 45ÿ988466ÿ149&ÿ96ÿ18549646ÿ34ÿ759&ÿÿ61431 1ÿ551ÿ;5ÿ449174ÿ99ÿ8ÿ49ÿ5383ÿ54486ÿ9&ÿ1ÿ34ÿ5145ÿ63464ÿ94564 0123140536ÿ893ÿ363208 ÿ6491ÿ9ÿ848ÿ6346ÿ484ÿ853ÿ81ÿ6396ÿ4ÿ1ÿ6013ÿ18498ÿ3ÿ 903ÿ38 3ÿÿ62ÿ8ÿ848ÿ634ÿ06ÿ43ÿÿ3905840536ÿ93 9401ÿ ÿ21439824ÿ62ÿ3953963 0123140536ÿ4ÿ848ÿ1396ÿ81ÿ848ÿ6396ÿ6ÿ3ÿ8 9 90843 ÿ01231405063ÿÿ4ÿ0181208 81ÿ439063ÿ3ÿ848ÿ649843ÿ3ÿ9843ÿ932314ÿ8936636ÿ4363ÿ06636ÿ81ÿ0ÿ353 53918123ÿ9439ÿÿ 1439ÿ3 ÿ4985339ÿ01ÿ43ÿ913ÿ4896ÿ8ÿ848ÿ90531ÿ981068401ÿ06ÿ43ÿ!848ÿ"203123ÿ# ÿ93339ÿ04ÿ301ÿ8ÿ9ÿÿ314608646ÿ4ÿ044ÿ81ÿ98ÿ9 3ÿ3ÿ3 1649843ÿ43 904ÿ4 3ÿÿ3139ÿ4ÿ4309ÿ3946ÿ0ÿ14ÿ6283ÿ3ÿ32863ÿ63ÿÿ43ÿ2813ÿ93$093ÿ2 14ÿ3ÿ820353ÿÿ64ÿ8ÿ9ÿÿ5 143396ÿ84%6ÿÿ43ÿ324053ÿ& 89ÿ3203ÿ4 ÿ3896 8ÿ4ÿ634ÿÿ8ÿ104ÿ484ÿ ÿ824ÿ86ÿ8ÿ'133ÿ231493ÿ06ÿ104ÿ ÿ6439ÿ8ÿ2104ÿ 848ÿ6203140646ÿÿÿ431ÿ 9'ÿ8 13ÿ01ÿ4309ÿ936324053ÿ1046ÿÿ81ÿ46ÿ312983ÿ2966( 3940068401ÿ81ÿ23ÿ68901ÿ"0089ÿ4ÿ43ÿ012314053ÿ06636ÿ891ÿ13960ÿ43ÿ!848ÿ"203123 #ÿ2ÿ0 953ÿ43ÿ0105086%ÿ0123140536ÿ4ÿ2 39843ÿ81ÿ6893ÿ23ÿ)3ÿ86ÿ31506013ÿ8 ÿ 9'01ÿ43439ÿ04ÿ*6 '36%ÿ01ÿ43ÿ439ÿ0506016ÿÿ43ÿ81'ÿ3053901ÿ583(801 9 3246ÿ1ÿ4363ÿ9 3246ÿ43ÿ#ÿ ÿ80ÿ4ÿ0 3314ÿ13ÿ6203140028 ÿ9531ÿ346+ÿ8 !848ÿ,-./0-/ÿ#ÿ1ÿ8ÿ4ÿ633ÿ484ÿÿ01ÿ9810601ÿ406ÿ21393123ÿÿ43ÿ!848ÿ"203123ÿ#ÿ06 48'01ÿ43ÿ21132401ÿ04ÿ43ÿ620314002ÿ2104ÿ63906 ÿÿ 234ÿ3ÿ23ÿ4ÿ8ÿ2 63ÿ)3ÿ893ÿ1ÿ8ÿ913ÿ82966ÿ431ÿ92'ÿ4399801ÿ&4ÿ43ÿ99366ÿ06 90601ÿ81ÿÿ 3ÿ4ÿ633ÿ81ÿ0143936401ÿ01016ÿ81ÿ63ÿ8 0284016ÿ936401ÿ9ÿ406 21393123ÿ1 ÿ301ÿ393ÿ01ÿ3961ÿ8'3ÿ13ÿ90316ÿ30604ÿ64398ÿ&4ÿ842ÿ4ÿ9ÿ43 0223ÿ90396+ÿ43ÿ893ÿ8ÿ810826ÿ04ÿ1ÿ9389ÿ9ÿ81ÿ034ÿÿ 5 ÿ393ÿÿÿ34ÿ3ÿ014923ÿ43ÿ134ÿ638'39ÿ)3ÿ893ÿ193ÿ4ÿ323ÿ9ÿ2'866 702'0ÿ2'866ÿ0ÿÿ8ÿ86ÿ34316053ÿ6395069ÿ33903123ÿ81ÿ06ÿ299314ÿ43ÿ#38ÿÿ43 "32ÿ321 ÿ81ÿ1158401ÿ3894314ÿ84ÿ43ÿ9 381ÿ831498ÿ&81'ÿ#3ÿ0ÿ30539ÿ43 0964ÿ'3143ÿ6332ÿ90531ÿ43ÿ64043ÿ:;<<=.-;>.?0@ÿ?BÿCDÿ;0EÿFGÿB?Hÿ<?=.-Iÿ;0Eÿ<HJE/0>.;= @J</HK.@.?0Lÿÿ ÿ853ÿ53ÿ4ÿ648ÿ81ÿ3ÿ016093ÿM1941843 ÿÿ853ÿ909ÿ2043146 81ÿÿ64ÿ3853ÿ ÿ01ÿ43ÿ2883ÿ816ÿÿ 18ÿ81ÿ81ÿÿÿ 81'ÿ ÿ539ÿ2ÿ9ÿ 9ÿ84431401ÿ1 ÿ43ÿ21393123ÿÿÿ | netherlands bank | 2,022 | 5 |
Speech (virtual) by Mr Klaas Knot, President of the Netherlands Bank and Chair of the Financial Stability Board, at the Green Swan Conference, 1 June 2022. | Speech Klaas Knot - “Propelling a graceful transition: the role of the financial system” (c) DNB For his speech at the Green Swan Conference, Klaas Knot spoke in his capacity as Chair of the Financial Stability Board (FSB) about the role of the financial sector in the transition to net-zero. He underscored the importance of incorporating climate risk into all financial decisions and noted that swift action is required to achieve this goal. He discussed the FSB roadmap for addressing climate-related financial risks as a key tool for coordinating this action. “The financial sector must play its part, both to help meet net zero targets and to manage the financial risks from climate change. The two goals are closely connected,” he said. Date: 1 June 2022 Speaker: Klaas Knot Location: Virtually Hello everyone. It is a pleasure to be here today – appropriately on screen and not on-site, thus leaving a smaller carbon footprint. The offices of De Nederlandsche Bank, where I usually work, have a view over the Amstel river. When looking out of my window, I regularly see swans on the river. It has a calming effect on me - seeing them gliding on the glittering water. They make it all look so effortless, graceful, smooth. There never seems to be anything urgent about their movements. But, such grace above the water conceals the effort of their feet just below the surface. This conference is about the role of finance in the transition to net-zero. Similar to the effort This conference is about the role of finance in the transition to net zero. Similar to the effort required for the swans to propel themselves, if the financial system is to play its part in a smooth and graceful transition, swift action is required. Climate risk must be incorporated into all financial decisions. This is a goal which will require significant changes to business practices and to policy. I want to join others at this conference in stressing the increasing urgency of such action. And I want to underscore the role that the FSB will play in supporting it. Russia’s invasion of Ukraine has demonstrated the reality of transition risk, and its relevance even over a short time horizon. It has triggered an intense debate about governments’ current and future energy policies, as it has profoundly changed the global economic and financial market backdrop. Public authorities are still overcoming residual challenges of the pandemic, and are now faced with rising commodity prices and inflation. Unsurprisingly, this has created pressure to deprioritize energy transition plans. In some cases, public and private-sector players are taking actions that are inconsistent with their stated net zero ambitions. The gap between commitment and action is growing ever wider. At the same time, risks from climate change keep rising. In February, the Intergovernmental Panel on Climate Change (IPCC) published its Sixth Assessment Report . It paints an alarming picture of the physical risks of climate change. The report warns of more frequent and intense extreme weather and climate events. It warns of unavoidable climate hazards over the next two decades even with global warming of the targeted 1.5 degrees. The consequences of exceeding that target are even more dire. Together, these developments should reinforce, rather than deflect from international sustainability ambitions. As I mentioned at the start, the financial sector must play its part, both to help meet net zero targets and to manage the financial risks from climate change. The two goals are closely connected. If the transition to a low carbon economy is delayed or disorderly, the global economy and financial system will face significant risks. This was the conclusion of recent climate scenario analysis and stress tests conducted by financial authorities across various jurisdictions. By further deepening our understanding of these financial risks, we can not only protect the financial system, but help to give greater impetus to a timely and orderly transition. The FSB roadmap for addressing climate-related financial risks has been developed to coordinate ambitious actions to assess and address these risks. Since the launch of the roadmap in July last year, progress has been made across all four of its building blocks: disclosures, data, vulnerabilities analysis, and regulatory and supervisory practices and tools. Allow me to briefly elaborate on these four building blocks, stressing their interdependencies. Let me start with disclosures. Work to strengthen the quality and consistency of climate-related financial disclosures has been moving forward rapidly. The International Sustainability Standards Board (ISSB) has made very encouraging progress, building on the Task Force on Climate-Related Financial Disclosures’ (TCFD) Recommendations. The ISSB’s two exposure drafts set out baseline standards for both general sustainability-related, and more specific climate-related disclosures. This marks a key milestone in the move towards establishing globally consistent, comparable and decision-useful disclosures. The ISSB is taking a building-block approach. This allows countries to use its common global baseline – and also be able to build on that baseline to develop national approaches to suit individual circumstances and priorities. This will provide jurisdictions with the flexibility to be more ambitious and go further or faster if they wish. At the same time, the common baseline will allow interoperability of approaches. Disclosures are important for investors’ financial decision-making but have wider importance too. They will provide necessary information on the progress being made by firms towards the transition, which is important to investors, but also to a wider set of stakeholders. Such disclosures must provide the information needed to assess the credibility of private sector commitment and action. The second building block is data. Firm-level disclosures are essential, but are not the only data we g y need. We also need macro-level data to help us determine which sectors of the economy are most at risk. We need government data. For example, on the policy plans to curb emissions and their effects. We need data on underlying climate risks, for instance on the frequency and severity of extreme weather events. Finally, to fully understand the systemic perspective, we will also need data to assess the degree to which climate-related risks might be transferred, amplified or mitigated by different financial sectors. Such data provide the raw material for the third building block of the FSB roadmap – vulnerabilities analysis. To examine vulnerabilities from a long-term, forward-looking perspective, it is critical to further develop scenario analysis, making use of the common NGFS climate scenarios. At the same time, we need to devise simpler indicators that can help identify the build-up of vulnerabilities. This is a key part of the FSB’s work on integrating climate-related risks into its broader financial stability surveillance framework. Improving our vulnerabilities analysis, in turn, forms the basis for the final block of our roadmap – regulatory and supervisory practices and tools. Sectoral standard-setters are doing important work already, by developing tools in their individual sectors. The FSB’s contribution is to help bind this work together by promoting consistency and effectiveness of approaches across sectors and countries. In April, we issued a consultation report on supervisory and regulatory approaches to climate-related risks. This report takes a cross-sector, cross-border perspective. It sets out high level recommendations on regulatory and supervisory data. Here the ISSB’s firmlevel disclosures provide a good starting point that provide the basis that supervisors and regulators can build upon for the development of standardised regulatory reporting requirements. A concern we often hear from financial institutions – with good reason I would say – is to ask authorities in different jurisdictions to standardise reporting where possible. As we put in place these new reporting requirements, we have an opportunity to ensure that they are well standardised from the start. Let’s take this opportunity. Scenario analyses are currently one of the most effective supervisory tools. They promote a more sophisticated understanding of risks by financial institutions, and how these risks connect with transition scenarios. Our consultation report encourages the expanded use of climate scenario analysis and stress tests to incorporate system-wide aspects of climate-related risks such as indirect exposures, risk transfers, spillovers and feedback loops. Our report also introduces some early thoughts on the use of macroprudential tools, which is still at a nascent stage. It highlights the early work of jurisdictions to develop macroprudential approaches and calls for further research to be undertaken to assist as we continue our journey to develop our macroprudential policy toolbox. Our public consultation closes at the end of June, and we would welcome your feedback by then. The final report will be published in October. It is almost a year now since we published our roadmap with its wide-ranging set of actions. To be more precise, coordinated actions by both public and private-sector players, to address climaterelated financial risks. To emphasise that point: the roadmap is deliberately designed as a joint endeavour. We need to combine our efforts for an efficient and comprehensive response to climate risk in the financial system. The FSB’s upcoming progress report, which will be submitted to the G20 in July, will provide a stocktake of how far we have come and what the next steps should be. Let me wrap up. The swans I see on the Amstel river, the ones that have a calming, mesmerizing effect on me are, of course, not the green swans this conference refers to. Nevertheless, they have some important commonalities. The gracefulness of a swan obscures what happens beneath the water’s surface. It conceals what it takes to propel action. It makes the hard look easy. In the same way, a graceful climate transition requires urgent action under the surface. As policy makers, we must ensure that the move to net zero is underpinned by a resilient financial system. One which can manage the challenges associated with climate change. And one which can propel the green transition forward. Members of the public may only see the outcome of such propulsion, just as I only see the swan above the surface. But, those who regulate, and operate within, the financial system know that the status quo will not suffice. Significant work is required. I look forward to doing that work together, so that we can make the graceful transition a reality. Thank you. | netherlands bank | 2,022 | 6 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the DNB-Riksbank-Bundesbank Macroprudential Conference, Santpoort-Amsterdam, 20 June 2022. | Speech Klaas Knot - “Macroprudential supervision: what’s in a name?” (c) DNB “The current macroprudential framework is not yet complete and effective to address all the different systemic risks within the financial system. We have to think about implementing the lessons from recent years, while also confronting new, upcoming risks like climate change and cyber risks,” said Klaas Knot on Monday 20 June, at the macroprudential research conference, jointly organized by DNB, Riksbank and the Bundesbank. In his opening address, he spoke about the origins of a macroprudential perspective on the financial system, its current relevance to support financial stability, and the challenges to address new upcoming risks like cyber risks and climate change. Date: 20 June 2022 Speaker: Klaas Knot Location: DNB-Riksbank-Bundesbank Macroprudential Conference, Santpoort Good morning. Welcome everyone at this joint macroprudential conference. After such a long time, it is inspiring to see a room full of researchers again, ready to share their latest ideas and insights among each other. I think you will all agree that the physical attendance of these conferences is much more interesting and useful than sitting behind our computers talking through Zoom or Webex. I thus hope you enjoy the upcoming two days here, with fruitful and active interactions. To give you some inspiration for this macroprudential conference, let me share with you some background on the importance of this topic. There is a great article from 2010 by Piet Clement who then worked at the BIS about the history of the term macroprudential . The term was first used in an international meeting in 1979 by Peter Cooke. He was head of banking supervision from the Bank of England and also well-known for chairing the Cooke Committee. As you may know, that committee turned out to be the predecessor of the Basel Committee. At that meeting in 1979, Peter Cooke identified the concern that microprudential vulnerabilities could transmit into macro-economic problems. Although the underlying analysis in itself was not new, it was the first time that this was explicitly identified as a unique concept in maintaining financial stability. But as it sometimes goes with great ideas. This new perspective did catch some attention at first, but it disappeared soon thereafter from the international agenda. It was not until the outbreak of the Asia-crisis in 1997-1998 that the macroprudential dimension made its comeback. That crisis was clearly characterized by problems in the financial sector as a whole and the problems spread through contagion across the entire region. In response to that crisis, the IMF - among others - developed a new macroprudential analytical framework, with the creation of the FSAP-program and the introduction of their Financial Stability Indicators. In addition, the famous Mr. Andrew Crockett, the long-time General Manager of the BIS, delivered a milestone speech in 2000 where he explicitly recognized that microprudential and macroprudential approaches are two separate dimensions that need to co-exist to maintain financial stability The definitive breakthrough of the macroprudential perspective came after the global financial crisis of 2008. One of the most important lessons from that crisis, as concluded in the different evaluation reports, was the absence of a system-wide view. Systemic risks can be regarded as some kind of coordination problem or market failure, which macroprudential policies try to adjust. This conclusion was followed by the creation of the European Systemic Risk Board (ESRB), national macroprudential authorities, and also the creation of the Financial Stability Board, which I currently have the honor to chair. So, nowadays macroprudential analysis is common and well-known. But let’s not forget that relatively speaking – it is still a relatively new field of research of our economic profession. And it is conferences like these, where we can further develop our ideas. And, most importantly, macroprudential policy has already proven its importance. When we were first confronted with the Covid-19 crisis, more than two years ago, the financial system was much more resilient than during the global financial crisis in 2008. Banks were better capitalized and had sufficient buffers to continue their lending to the real economy. As a result, the financial sector was able to absorb, rather than amplify the external shock. More recently, we were confronted with the invasion of Ukraine. This is of course predominantly a humanitarian crisis, but also has profound economic and financial effects. For now, the financial system has weathered the challenging economic conditions very well, thanks to a more resilient financial system. And we are making active use of macroprudential instruments. For example, in the Netherlands we have recently decided to activate the countercyclical buffer to strengthen the buffers of banks. At the same time, our macroprudential toolkit remains incomplete in some areas. For example, we have imposed higher risk weights for mortgage portfolios of banks, but we don’t have instruments of LTV/LTI limits to curb excessive lending in the housing market. Also, we don’t have many macroprudential tools in the non-bank financial sector. So there is still a lot of work to be done. For the final part of my introduction, let me now look forward to the upcoming two days of this conference. I am happy to see such a wide-range of topics on the agenda that will be discussed in the different sessions. Let me provide you with three examples of different sessions where you have a great opportunity to think about how the macroprudential framework could be further developed. First, the systemic risks of climate change are becoming increasingly prominent. International regulators and supervisors are working towards better data and enhanced disclosures. You will discuss a paper on how technical developments will allow a more precise monitoring of financial risks of climate change. For example, how we could better analyze the degree of concentration in the portfolios of financial institutions and investors and how it affects financial stability. Second, another important trend is that financial institutions are crucially vulnerable to cyber risks. In addition to institution-specific risks, we should better explore how these risks are interconnected in the financial system. This is something that we are currently also working on at DNB to develop a macroprudential perspective on cyber risks. At this conference, there is interesting research on which transmission channels can amplify or dampen shocks. It shows that the financial impact will depend on the objective of a cyberattack and the fragility, adaptability and complexity of the system. These are interesting findings which could help us to better mitigate these risks. Third, you will discuss the critical relationship between competition, regulation, and stability. In economics, there has been a long and fundamental debate between the two extreme outcomes to strictly regulate markets or take a more liberal approach. Research shows that there is no single answer. The challenge is how to balance these aspects by maintaining financial stability, while also promoting competition and innovation in the financial sector. There is also an interesting policy panel on the agenda. These different studies inspire some interesting questions. For example: First, which data do we need to integrate climate change within our financial stability assessment and what supervisory practices can we apply to address the macroprudential aspects of these risks? Second, what is the macroprudential perspective of cyber risks and which amplification effects can occur within the financial system as a result of cyber-attacks? Finally, how can we manage the trade-offs between competition and stability, for example in the current crypto-assets market. There are potential benefits of competition and innovation. However, many elements like excessive risk taking, high leverage, credit bubbles and misconduct are also present there today. I am very curious to hear the opinion of the panel on these topics. With the rich agenda and these interesting questions before you, I will not take any more time. This conference was planned for 2020 and it has been postponed for two years. That is not all bad, because academic papers – just like wine - tend to get better over time. And please, don’t be disappointed, if your conclusions or proposals are not picked up right away. As I have shown you in the beginning, sometimes it may take up to twenty years to recognize great ideas. And now, allow me to introduce Pablo Hernández de Cos, keynote speaker of the day. First, Pablo, let me welcome you to this remarkable location. It is a historical site that dates back to the 17th century. It was used during that time by our Royal family as summer residence and place for hunting. During its history, this location has changed its function many times ranging from a private estate… to a Catholic church…. to a recovery center for soldiers and conference venue of a large Dutch commercial bank. In addition – and this will probably not say much to any of you – it is also the location of a famous soap opera on Dutch television. Pablo, as chair of the Basel Committee, I think you can appreciate the dynamic and flexibility of this location, which in a sense reflects your presidency of the Basel Committee. Of course, I am not comparing the Basel Committee to a soap opera. I am just saying that you have overseen a turbulent period in the last three years. You not only had to deal with the Covid crisis, but also had to deal with the finalization of the Basel IV agreement. It shows the intriguing world of international regulation and supervision. There was always a lot of suspense, with some tensions, unexpected twists and memorable steps. And - thanks to your efforts - always a good outcome in the end. And there is always a new episode with new challenges and open questions ahead. I think you will agree with me that the current macroprudential framework is not yet complete and effective to address all the different systemic risks within the financial system. Moreover, we have to think about implementing the lessons from recent years, while also confronting new, upcoming risks like climate change and cyber risks. In that context, I very much look forward to your views on the development of the macroprudential framework, including the ongoing consultation for reform within Europe. With that, I will give back the floor to you and wish you a great conference. Thank you. | netherlands bank | 2,022 | 6 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Keti Koti - the annual celebration and commemoration of the abolition of slavery, Amsterdam, 1 July 2022. | Speech Klaas Knot - “Keti Koti 2022 marks turning point for DNB” 01 July 2022 General “Today, on behalf of De Nederlandsche Bank, I apologise. I offer our sincere apologies to all descendants of enslaved people in the Netherlands, in Suriname, in Bonaire, Sint Eustatius and Saba, in Aruba, Curaçao and Sint Maarten. I apologise to all those who, because of the personal choices of many, including my predecessors, were reduced to the colour of their skin. I apologise to everyone who still bears the consequences of those choices even today.” Klaas Knot spoke these words on 1 July 2022, Keti Koti, the annual celebration and commemoration of the abolition of slavery. He also stressed that DNB is not only opting for words, but also deeds. Deeds that will set us on course for a more inclusive future. Date: 1 July 2022 Speaker: Klaas Knot Location: Slavernijmonument, Amsterdam Pieta. Twelve hundred guilders. Zaterdag. Thirteen hundred guilders. Pierot. Five hundred guilders. “Old”. August. Three hundred guilders. “Sickly". Claartje. Zero guilders. “Worthless”. Their names, their economic value, and a note on their health. This is how enslaved people were recorded in a ledger when they were bought or sold. A ledger from a sugar and coffee plantation in Suriname. A ledger that was kept for one of the plantation owners: Jan Hodshon. The same man who, in 1816, two years after the abolition of the trade in enslaved people in the Netherlands, two years after De Nederlandsche Bank was established, and after having been a board member for two years, became president of De Nederlandsche Bank. A position he held for nine years. And all the while, these kinds of ledgers were kept for him. All the while, he profited from slavery. And all the while, as he looked around the boardroom at the bank, he saw that he was no exception. Personal involvement in slavery was nearly ubiquitous among members of the board. And when slavery was hotly contested in the Netherlands, the members of DNB’s board did their best to keep the political winds blowing in their favour. My predecessors on the board of De Nederlandsche Bank had plenty of time to My predecessors on the board of De Nederlandsche Bank had plenty of time to choose otherwise. They did not, however. This is how the history of De Nederlandsche Bank begins, the institution whose mandate is to ensure that people can have confidence in the financial system. A history that the current board is thoroughly and painfully aware of, thanks to the independent study conducted by researchers at Leiden University. A history that provides the current board with a clear mandate. A history that inextricably links my fellow board members and me to boards of past generations. The current board, however, has resolutely decided to take a different path. On behalf of De Nederlandsche Bank, I acknowledge that many of my predecessors viewed people as nothing more than merchandise. That many defended the existence of slavery and the prolongation of slavery. And that many later ignored the ramifications of slavery for a long, long time. On behalf of De Nederlandsche Bank, I also acknowledge our involvement as an institution. Some of the money that served as DNB’s start-up capital was earned from slavery. DNB accepted products from the plantations, such as coffee and sugar, as collateral for a loan. And when slavery was abolished, DNB paid compensation to plantation owners on the instruction of the Ministry of Colonies, including to board members of De Nederlandsche Bank. On behalf of De Nederlandsche Bank, the current Executive Board today apologises for these reprehensible facts. We offer our sincere apologies to all descendants of enslaved people in the Netherlands, in Suriname, in Bonaire, Sint Eustatius and Saba, in Aruba, Curaçao and Sint Maarten. We apologise to all those who, because of the personal choices of my predecessors, were reduced to the colour of their skin. To an amount. To a commodity listed in a ledger. We apologise to everyone who still bears the consequences of those choices even today. Over the past few months, I have heard many personal stories – stories of suffering, but also of resistance and struggle. I heard painful stories. I learned a great deal. And it hurt. What I heard brought the suffering of the past and present very close to home. And at the same time, that suffering remained terribly, disconcertingly distant for someone who grew up in the far north of the country. The conversations I had made it clear that the suffering of long ago is far from over, that the fight is far from over. We therefore choose not only to apologise today. We are opting for more than just words, but also for deeds. Deeds that will hopefully contribute to the fight against racism, inequality and injustice. Deeds that we can accomplish today. Deeds that will set us on course for a more inclusive future: We are setting up a fund that we will use to finance projects in the service of society – projects related to education, healthcare, employment and more. Projects in the Netherlands in the Caribbean and in Suriname This fund will Projects in the Netherlands, in the Caribbean and in Suriname. This fund will finance projects worth €5 million over the next ten years. In addition, we are providing one-off funding of an additional €5 million for a number of larger initiatives such as the National Research Centre on the History of Slavery. We are also closely examining our own organisation. We need to become more diverse and more inclusive, and we will put forth every effort to make that happen. We must ensure that we ar e better able to detect and recognise racism and respond to it decisively. And we intend to boost diversity at De Nederlandsche Bank in our recruitment & selection procedures, through internships and traineeships, and in promotions. Moreover, we will not conceal our past, which we have now come to know more acutely. Our history will be given a prominent place in our Amsterdam headquarters, serving as an invitation for further dialogue. A dialogue that we will also pursue using works of art from our vast collection, a collection which we will moreover recast with greater emphasis on diversity. The words I speak today, and the deeds I am announcing today, do not signify the end of a journey for De Nederlandsche Bank, but rather a turning point. For De Nederlandsche Bank, 1 July 2022 signifies a touchstone as we look to the future. A future in which DNB is more inclusive. A future – I hope – with a more inclusive society. A future – I hope – with each other. Thank you for allowing me, on behalf of the entire Executive Board of De Nederlandsche Bank, to stand before you here today and deliver this message. | netherlands bank | 2,022 | 7 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Danske Bank, Copenhagen, 30 August 2022. | “A time to act. The outlook for monetary policy in the euro area.” Speech by Klaas Knot at the Danske Bank Copenhagen, 30 August 2022 There is no time for tinkering. We must forcefully tackle the still growing problem of persistently high inflation, within the core of our mandate. Let me recap the reasons behind this urgency. Euro area headline inflation reached 8.9% yoy in July, the highest figure since the creation of the euro (see Figure 1 below). 10.5 8.5 Figure 1. HICP euro area (Percentage points contribution to HICP) 6.5 4.5 2.5 0.5 -1.5 jan-19 Food jan-20 NEIG jan-21 Energy Services jan-22 HICP Core inflation In explaining high inflation, much attention has focused on energy and food price inflation, which have provided the largest contribution to headline inflation, and which are driven by negative supply shocks related to supply chain constraints and Russia’s war in Ukraine. But this is not the full story. Positive demand shocks – related to the strong pick-up in demand following the relaxation of COVID-19 restrictions – have also been at play. To me, two main types of evidence point to an important role that demand shocks have played so far. First, for some time now, inflationary pressures have been increasingly broad-based. The contributions to headline inflation of non-energy industrial goods- and services inflation have steadily increased in recent months (see Figure 1). Note that services, which are not directly affected by higher commodity prices and disrupted production chains, account for 42% of the euro area HICP. Moreover, measures of underlying inflation that we monitor closely to see through temporary shocks have been increasing further, and currently stand at or near their historical maximum (see Figures 2 and 3). Most notably, core inflation is on the rise and reached 4% in July. As a number of temporary measures introduced to fight high inflation, such as the German nine-euro public transport ticket, are set to expire, it is unrealistic to assume that core inflation has peaked. 10.0 Figure 2. Measures of underlying inflation (Annual percentage changes) 5.0 0.0 -5.0 HICP HICP excl energy and food HICP excl energy, food, travel-related services, clothing and footwear supercore Figure 3. Measures of underlying inflation (Annual percentage changes, box plot) -2 HICP HICPX HICPXX 25e-75 percentile Max-min 1999-'22 PCCI Supercore Median Last known Trimmed mean (20%) Second, not only inflation but also GDP growth kept surprising us on the upside post-pandemic (see Figure 4), and Q2 was no exception to that rule. An exclusive incidence of negative supply shocks would likely have generated disappointing growth outcomes alongside higher inflation. A recent analysis by DNB staff, which decomposes forecast errors of the ECB’s inflation projections since June 2021 into demand and supply shocks, indeed confirms that high inflation has been driven not only by negative supply shocks but to a significant extent also by positive demand shocks. Figure 4. 2021 euro area inflation and growth higher than expected June projection 2021 realisation 2021 inflation core inflation gdp-growth This is not to disregard the large uncertainty surrounding the outlook for growth, but to underline the resilience of demand we have seen so far. The economy has held up well, and some of the factors behind the positive GDP surprise in Q2 might well spill over to Q3 (think about tourism). Looking further ahead, recent indicators (PMIs) do point at declining activity and business- and household confidence in the euro area. Yet, even if this slowdown were to materialize, this in itself is unlikely to bring inflation back to our objective over the medium term. Taken together, all this evidence is fueling my concerns that inflation will remain high for quite some time to come. In that context I find it striking that markets have shifted their expected path of euro area inflation further out in time and now expect headline inflation to peak only in 2023Q1. On top of that, I see several upside risks to inflation. First, high energy and food price inflation may turn out more persistent than expected, as I for instance fail to see a swift resolution of the Ukrainian conflict. Second, inflation expectations could become de-anchored, should high inflation persist. Although there is no clear evidence of a wage-price spiral yet, wages are creeping up on the back of an increasingly tight labor market. Third, while in the euro area exchange rate pass-through to inflation is far from complete, a depreciating euro/dollar rate can have significant effects on headline inflation, particularly in a context of very high commodity prices. And the fourth risk relates to fiscal policy. Recent budgetary decisions suggest that fiscal support will continue to be substantial, even though the euro area economy has been growing strongly and labor markets have remained extremely tight. Some countries recently announced an extension of 2022 fiscal packages and/or additional support measures for 2023. While such policies can buffer the impact of negative supply shocks for instance on our citizens’ purchasing power, they sustain upside risk to inflation. On policy I would like to emphasize that the broadening and deepening of our inflation problem generates the need to act forcefully. A swift normalization of interest rates is an essential first phase, and some front-loading should not be excluded. There is, however, inherent uncertainty surrounding the neutral rate as well as on the question whether going to neutral will be sufficient to bring inflation back to target. This implies that the path and end point for the policy rate remain uncertain. It would probably serve us well to simply continue raising our policy rates until the inflation outlook becomes consistent again with our symmetric 2% target over the medium-term. As model outcomes inherently lack robustness in the aftermath of such unprecedented shocks, we need to give more weight to actual underlying inflation dynamics in our monetary policy decisions. That also implies that we will continue to take our decisions on a meeting-by-meeting basis. Beyond policy rate increases, the relatively flat yield curve shows that the size of the central bank’s balance sheet is and should become an important element of the normalization process as well, and I expect the issue of APP-reinvestments to feature more prominently in our discussions at a later point in the year. Thank you. | netherlands bank | 2,022 | 8 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Eurofi 2022 Financial Forum, Prague, 9 September 2022. | Speech Klaas Knot - “From thaler to tackle. On how to lift us out of the current crises” 09 September 2022 General “The early days of the pandemic serve as a stark reminder that - in our globalized economies - inward-looking policies almost always lead to a negative sum game. This means that financial institutions, businesses and governments should each consider the wider impact of their decisions. Each of us has a role to play when it comes to limiting the perils of cross-border spillovers. To maintain our balance, we rely on the international coordination of policymakers and industry leaders. Our teamwork determines the resilience of the real economy and, in particular, its financial system.” This is what Klaas Knot emphasized at the Eurofi 2022 Financial Forum. Date: 9 September 2022 Speaker: Klaas Knot Location: Eurofi 2022 Financial Forum, Prague Hello everyone. As a central banker, to be in the Czech republic is a special feeling for me. Do you know why? Because if it were not for Czech ingenuity the world would likely have looked quite different. And no, I’m not talking about essential Czech inventions such as mechanical pencils, sugar cubes or pilsner. I am talking about something the financial industry is much more fond of…… In a way, the seeds of our shared monetary history lay in the tiny town of Jachymov. For it was there, at the dawn of the Renaissance, that the rulers of Bohemia started minting coins that would later serve as the prototype for all major Western currencies. With an image of saint Joachim on the front and the Bohemian lion on the back, the new currency was labelled as “Joachimsthalers” – which soon was shortened to “thalers”. With the helping hand of the Holy Roman Empire, the thaler spread across Europe. From here it was just a matter of time before the Dutch brought the Leeuwendaler to New Amsterdam. And after New Amsterdam turned into New York, the Leeuwendaler turned into the dollar. By passing through the Joachimsthalers from neighbor to stranger, our ancestors breathed life into our financial system. They relied on each other to spread their currencies across the globe. They relied on their currencies to improve their welfare and wellbeing. That interdependence still persists in our financial system today: we need strong, stable and sustainable finances to ensure and support welfare and wellbeing. This is a balancing act that requires all of us to weigh in. For there are many challenges that can disturb the balance. Wh thi k f th t i fi i l h ll i ti f th id When we now think of the most pressing financial challenges our societies face, the rapid revival of inflation stands out. The strong price increase for energy and commodities in particular has hit societies all over the world with force. Pushed past its point of inflection, inflation eats away at consumption and investment capacity and frustrates financial planning. In response, the ECB rallied to raise policy rates to calm down the business cycle and keep inflation expectations anchored. We will continue doing so until the inflation outlook has stabilized around our 2% target in the medium term. This can however hardly be considered a walk in the park. First of all, some of the most important inflationary drivers are of an imported nature. This not only makes us collectively poorer as we spend more euros or koruna’s abroad, but also makes inflation more complicated to control. Secondly, central bankers are having to walk a tight rope between controlling inflation and preserving financial stability. In the aftermath of the pandemic, debt levels and asset valuations peaked. Both make our system vulnerable to disorderly market corrections and cross-border spillovers. Given these considerations, one might ask oneself what we can do. Recent analysis by DNB staff confirms that high inflation has been driven not only by negative supply shocks but to a significant extent - also by positive demand shocks. With the tightening of monetary policy, European governments should be mindful not to implement generic fiscal support measures. Instead, targeted fiscal measures should focus on distributing support where needed most. This would also demonstrate our commitment to budgetary discipline. But our interdependence goes much deeper. The early days of the pandemic serve as a stark reminder that - in our globalized economies - inward-looking policies almost always lead to a negative sum game. This means that financial institutions, businesses and governments should each consider the wider impact of their decisions. Each of us has a role to play when it comes to limiting the perils of cross-border spillovers. To maintain our balance, we rely on the international coordination of policymakers and industry leaders. Our teamwork determines the resilience of the real economy and, in particular, its financial system. For the longer term, our response should focus on building more structural, more sustainable resilience. This can be done in many ways, but allow me to highlight a few important ones: First, further integration of our banking and capital markets will strengthen our capability to withstand asymmetric shocks. This – and only this – will help us to break definitively with the ghosts from the past Eurocrisis, withstand future shocks, and unlock the full potential our financial economy has to offer. Second, we should push for the harmonization of international regulatory standards. A global level playing field minimizes regulatory fragmentation and allows for the most efficient allocation of capital. In practice, this means the EU should strive for the full, timely and consistent implementation of the Basel III accords. Third, we should strive for more proactive use of macroprudential policy space. In times of relative ease, we should prepare the financial sector for when the tides turn. As they always do. Right now, macroprudential buffers in the Eurozone are not in line with the elevated levels of systemic risks. Uncertainty about the future should stimulate action rather than wait-and-see behavior. Partly, for this reason, the Dutch Central Bank recently announced the activation of the releasable Countercyclical Buffer. Additionally, more dedicated macroprudential policy tools that address risks stemming from non-banking financial intermediation (NBFI) would be a welcome addition to our toolkit. For insurers, it is key that macroprudential concerns are well-incorporated in the regulatory framework so that authorities have the necessary tools to mitigate systemic risks, for example by reinforcing the financial position of insurers in exceptional circumstances. Moreover, the operationalization of already available tools, such as the leverage limit for open ended funds, would help address procyclical behavior. However, our shared responsibility extends beyond the financial system and the real economy. Last February, the Intergovernmental Panel on Climate Change (IPCC) published its most alarming Assessment Report to date. Since then, the world has, once again, experienced its warmest summer to date. In Europe, we saw devastating wildfires, torrential rains and droughts. Water levels in some of our primary rivers, such as the Rhine, were so low that shipping was obstructed. Often in the very same places that suffered from the July floods in 2021, the costliest natural disaster in Europe since 1970. More and more often, physical risks impact our supply chains. As a result, they aggravate already severe pandemic-related disruptions and increase price levels further. Climate risk is not something to worry about tomorrow, climate risk is something to worry about today. Especially because we did not worry enough yesterday…. In addition, research by DNB and our international counterparts shows that nature-related risks surrounding biodiversity also are in need of our attention. The green transition can no longer wait. We need to step up: As Václav Havel put it: “Vision is not enough, it must be combined with venture. It is not enough to stare up the steps, we must step up the stairs.” The implementation of sustainable finance is our venture, our decisive step up the stairs. We must implement serious climate policies which take into account the negative externalities of carbon emissions. That means encouraging sustainable initiatives rather than subsidizing fossil fuels. That means incorporating ESG risks into our policies and business strategies. That means providing a wide array of sustainable and transparent financial products for our clients and partners. At the end of the day, renewables also remain our best bet to establish energy security. Fortunately, the financial sector overwhelmingly supports the Paris Agreement and pledged en masse that they – that we – will do our part to establish a net-zero economy. While more is still needed available capital should be put to maximum use For financial While more is still needed, available capital should be put to maximum use. For financial institutions, this means implementing proper risk management policies to price in ESG risks. But for risks to be understood by the broader public, we also need common reporting regimes. In this regard, I applaud the ambitious EU initiatives regarding climate disclosures. At the same time, financial institutions have voiced concerns regarding the different metrics that are currently being drafted between the Eurozone and standard setters such as the ISSB. Therefore, I would like to echo my previous message regarding the harmonization of regulatory policy. By designing internationally comparable climate disclosures from the start, we maximize their impact. This puts the industry in the best possible position to put their capital to work. Just as our ancestors joined hands to create a strong financial sector by means of the Joachimsthaler, we now have to honor their legacy by keeping it that way. Today, a strong financial sector requires resilience and a transition to a balanced, sustainable economy. We do so together, but all in our own way, relying on our own strengths. As Madeleine Albright, daughter of a Czech diplomat, once said: “The main thing is to remain oneself, under any circumstances; that was and is our common purpose.” In times of growing challenges to price and financial stability, there is great value in our combined effort. It is our European identity to come together and serve as a positive example for others. Once again, we have to transform our interdependence into collective action. We all have our role to play. Thank you. | netherlands bank | 2,022 | 9 |
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ÿ6ÿ12ÿ33ÿ23ÿ952ÿ13ÿ $92ÿ3ÿ133ÿ65ÿ91ÿ31ÿ61ÿ91ÿ9ÿ53153ÿÿ4731 ÿ$92ÿ3ÿ133ÿ65ÿ9ÿ+4331 (167231312 '1ÿ973ÿÿ74331ÿ43951ÿ91ÿ74331ÿ635ÿ$3ÿ9112ÿ39%3ÿ292ÿ2ÿ23ÿ34ÿÿ23 ,-.,/,012ÿ91 0ÿ912ÿ2ÿ533ÿ3456ÿ91570ÿ9ÿ61 '43ÿ8 "91ÿ9 | netherlands bank | 2,022 | 9 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, to the Economic and Financial Committee, at the Rijksmuseum, Amsterdam, 23 September 2022. | Speech Klaas Knot - “Spreading our wings. How monetary and fiscal policy can fight inflation” 23 september 2022 Algemeen “The job for central bankers is clear. Like on the painting, we will rise up, fiercely spread our wings, and protect our eggs from the menacing mongrel of inflation,” said Klaas Knot, referring to "The Threatened Swan" at the informal dinner of the Economic and Financial Committee at the Rijksmuseum. "For many of us here tonight, the dog in the water is inflation. For others, it is the energy crisis. The refugee crisis. The climate crisis. The pandemic. An atrocious war on European soil." Klaas Knot President , De Nederlandsche Bank Datum: 23 september 2022 Spreker: Klaas Knot Locatie: Rijksmuseum, Amsterdam Good evening, distinguished members of the Economic and Financial Committee. From me too: welcome to the Rijksmuseum. The most famous painting in this impressive museum is probably the one right behind me. The Night Watch. But right here in this beautiful gallery, you will also find the very first painting the Rijksmuseum ever acquired. It is called “The Threatened Swan”. You should find a small reproduction of this painting on your menu. If you look at it, you see a swan with its wings spread wide, defending its eggs against a dog that is sneaking up through the water. This painting is seen as an allegory for what happened to us in 1672. The year that in Dutch history books is marked as “The Disaster Year”. “The Disaster Year” because in that year, the Dutch “Republic of the 7 Provinces” was under fierce attack. Simultaneously from the English in the west, the French in the south, and y g , , German armies in the north. The allegory that is represented by “The Threatened Swan” also goes beyond 1672. Essentially, it is a painting about hard times, about being under threat, and about how you respond. Also today, 350 years later, we find ourselves facing hard times, experiencing several threats, and asking ourselves how to respond to them. One of these threats is an inflation rate that we have not seen in decades. Inflation that is now expected to stay well above our target for an extended period of time. Inflation that is jeopardising the livelihood of many millions throughout Europe. So, looking at my fellow central bankers here tonight, I must ask: what will we do? Shall we sit quietly? I don’t think so. No, the job for the central bankers among us is clear. Like on the painting, we will rise up, fiercely spread our wings, and protect our eggs from the menacing mongrel of inflation. Hence the ECB’s recent move – to raise interest rates by 75 basis points. As my central bank colleagues gathered here tonight will confirm, this major transition in monetary policy was a necessity. At current inflation levels – levels that are threatening our European prosperity – we need to rapidly transition away from a highly accommodative monetary policy to interest rate levels that will support a timely return to our inflation target of two percent over the medium term. And I anticipate further rate hikes over the coming months, to be specified meeting by meeting, based on data, and guided by our objective of price stability. But we know that, even with our recent, major changes to monetary policy, it will take time for these changes to take effect in the economy and actually bring inflation down. That is why I am grateful to be here. However much I like preaching to the monetary choir in this room, being here gives me the opportunity to address the full EFC, including member states’ finance ministries, the European Commission and related agencies. Hence, an opportunity to re-emphasise the value of working together. In the aftermath of the global financial crisis, after 2008, monetary and fiscal policy were each fighting their own battles. Partly due to this, and with the benefit of hindsight, economic recovery was slowed down. More recently, a mere two and a half years ago, the dog in the water was the corona virus. In the meantime, however, we had learned valuable lessons from the past. So when the pandemic hit us it was a swift and balanced cooperation between monetary and fiscal pandemic hit us, it was a swift and balanced cooperation between monetary and fiscal policy that gave our economy wings to fight back. And that is what we need to do now as well: to jointly work towards our common goal – a secure and prosperous Europe. Needless to say, each within our own mandate. But I would also like to express a word of caution though: fiscal measures that are aimed at compensating households for high inflation might themselves become inflationary when they further increase the imbalance between supply and demand. And higher inflation would in turn require, again, a firmer policy response from central banks. But from a democratic, and perhaps more importantly, moral stance, the valid question remains: what can governments do to alleviate some of the worst economic pain without increasing price pressures further? First of all, we probably all agree that the most vulnerable households need to be helped with well-targeted financial support. For a lot of other households, compensation should come from targeted wage growth. While it is paramount to avoid a wage-price spiral, it is also important that wages rise in sectors of the economy that have the scope to do so. Second, governments should address supply-side restrictions more directly where they can. On the energy market, this means achieving a more balanced mix of energy sources as soon as possible. On the labour market, this means removing the impediments that constrain labour supply growth – there is still room for improvement in labour participation in several European countries. Third, the economic reform agenda and the public investments that can boost potential growth must continue. And preferably, this will be done without further deficit spending, because public debt levels are already uncomfortably high. If you look again at “The Threatened Swan”, you will see a very natural phenomenon: a swan defending her eggs. But the swan is also fierce and grand. Filled with passion. Filled with conviction. If it could, the swan would march right into this gallery. For many of us here tonight, the dog in the water is inflation. For others, it is the energy crisis. The refugee crisis. The climate crisis. The pandemic. An atrocious war on European soil. Each and every one of us, here or elsewhere, each in their own capacity, should step forward, spread their wings wide, and defend, fierce and grand, with passion, with conviction, the eggs of our times. I thank you and wish you a very pleasant evening. | netherlands bank | 2,022 | 9 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, on the thirtieth birthday of the Maastricht Treaty, at the conference "Euro at 20: shifting paradigms?", Maastricht, 27 September 2022. | Speech Klaas Knot - Working on progress. On public and private risk sharing in the EMU 27 september 2022 Algemeen “We have thirty years of experience to learn from. Thirty years of crises and successes, of design flaws and great innovation, of opportunities for reform that we have missed, and opportunities for prosperity gains that we have seized.” This is what Klaas Knot said on the thirtieth birthday of the Maastricht Treaty. In his speech, he stressed that the Economic and Monetary Union is a work-in-progress, but also that we need to keep working on that progress, and that “whatever way you look at it, going forward means, at least partly, increasing risk sharing. And I mean crossborder risk sharing. This means using the strength in our numbers to absorb possible shocks.” "In a sense, the fall of the Berlin Wall led to the rise of the Economic and Monetary Union." Klaas Knot President , De Nederlandsche Bank Datum: 27 september 2022 Spreker: Klaas Knot Locatie: “Euro at 20: shifting paradigms?”, Maastricht Hello everyone. And happy birthday! Happy thirtieth birthday to the Maastricht Treaty. What better place to celebrate this birthday than here – in the Statenzaal – the very room where the Maastricht Treaty was signed. I remember this historic event vividly. Just like I vividly remember what happened only a few years before: the fall of the Berlin Wall. In a sense, the fall of the Berlin Wall led to the rise of the Economic and Monetary Union. Because after 1989, Germany once again wished to become a unified nation. But other European nations, principally the French, were hesitant. A unified Germany would de facto set the economic and monetary tone for a lot of other European countries. And so those countries were keen to ensure that a reunified Germany would remain embedded in a countries were keen to ensure that a reunified Germany would remain embedded in a united Europe. That is why discussions on the economic and monetary union gained momentum – eventually leading to the deal between Mitterrand and Kohl: unification for you – the euro for us. And for the past twenty years, the euro has been the very bedrock of our single market. The absence of exchange rates has been an impressive impetus for prosperity – in the entire euro area. Being a unified economic block has brought much stability. And as a central banker, that sounds like music to my ears. But… indeed, there is a but. At the start of the EMU, in 1999, per capita income levels between countries differed significantly. It was expected that the EMU would level these differences. It was expected that countries that had catching-up to do would experience faster economic growth. That we would see sustainable economic convergence in Europe. And to some extent this happened. But – here it is – it did not happen quite as across the board as was expected. In terms of real GDP per capita, we mainly saw east-west convergence. So between the original twelve countries on the one hand and the seven, soon eight, countries that joined later, on the other hand. So it is no wonder that, despite past crises and the pervasive pessimism in some European corners, a lot of countries are still very eager to join our economic and monetary union. As far as north-south convergence goes, the first decade of the euro demonstrated the expected economic convergence within the original group of member states. But much of that convergence proved unsustainable and disappeared again after the global financial crisis. In 2010, the EMU even suffered a crisis that threatened the very existence of the euro. This taught us that it is much harder to achieve convergence that goes beyond the initial convergence that comes with the entry to the euro area. This further convergence will only be possible when we address a number of design flaws in the euro area’s construction. Design flaws that the signatories to the Treaty did not expect nor foresee. As you will remember, the way out of the 2010 eurocrisis consisted of acute, collective help for individual countries and banks – but also the creation of several European institutions to increase the EMU’s resilience. We now have common supervision of major financial institutions, a single resolution fund for failing banks, and the European Stability Mechanism to help when sovereign nations get in trouble. And more recently, we also set up a Recovery and Resilience Facility to collectively and effectively tackle the economic outfall of the pandemic. So now that the EMU has proven itself to be an adaptive project, where do we go from here? This is, of course, mainly a political question. And while the eurocrisis was an impetus for improvement, for making progress, we currently find the EMU too often at a standstill. To get past that, the following political question needs to be resolved at the very least – what should be done first: increase risk sharing in the EMU or decrease existing risks within individual countries? I am a central banker. I look at things from an economic standpoint. And in that capacity I can say that the longer we have a standstill, the more vulnerabilities between eurocountries will grow, the deeper future economic crises will be, the more emergency support will be needed, and the less prosperity we’ll have – all of us. So for me, as an economist, too long a standstill is not an option. We must go forward. And, whatever way you look at it, going forward means, at least partly, increasing risk sharing. And I mean cross-border risk sharing. This means using the strength in our numbers to absorb possible shocks. And when I talk about cross-border risk sharing, I have to distinguish between public and private risk sharing. The first goes through governments. The second through credit or asset markets. Currently, compared to other monetary unions like the Unites States, risk sharing in the EMU is low. Especially private risk sharing. To bolster such private risk sharing, we need, first, a stronger banking union. The great financial crisis and the pandemic showed us that the banking sector and the public sector are closely linked financially. That risks easily find their way onto banks’ balance sheets. To some extent, we should use this to smooth the economic cycle and absorb shocks more evenly – to increase our resilience, but, of course, without repeating the past, in which depositors and tax payers ultimately took the hit. Alongside the European supervision and resolution authorities I already mentioned, the completion of the banking union with a common deposit insurance programme would also greatly contribute to economic and financial resilience. Together with risk-based capital requirements on sovereign exposures, a European Deposit Guarantee Scheme would delink the financial health of banks from the countries in which they are located. Additionally, the presence of a common deposit guarantee scheme would function as the foundation for deep integration of banking credit markets. This would significantly diminish the risk of crises spilling over national borders and causing financial distress in other EU countries. This would also enable banks to better absorb local economic shocks, and thus increase economic resilience. In addition to a stronger banking union, we need a stronger capital markets union to bolster private risk sharing. Well-developed and integrated capital markets lead to more risks being shared privately, they reduce systemic risk and they stimulate diversification of the funding mix of corporates. All this adds to our resilience as an economic and monetary g p y union. In theory, the EMU opened the way for the free movement of capital. But in practice, we see that European financing remains too one-sided – firms and households depend too much on banks, and the home bias of both investors and banks is persistent. So we are not using the numbers in our union to decrease risk. Cross-border risk sharing remains low. One reason could have to do with cross-border public risk sharing. Here, too, I am referring to the past to learn about where to go in the future. Because I know of very few historical examples where strong cross-border private risk sharing developed without, or before, a significant degree of cross-border public risk sharing. So to some degree the two are complements rather than substitutes. In other words, the EMU needs both. The recent Recovery and Resilience Facility that I already mentioned, is a telling example of such cross-border public risk sharing. The fund was set up to temporarily support public investments in the energy transition and in digital projects all over Europe. Investments that strengthen the economic growth potential, and thus the capacity of the EU as a whole to absorb shocks – including in countries facing greater financial constraints. The RRF is temporary because continuous large transfers of public funds would make the project vulnerable from a political perspective. However, the mere existence of this successful cross-border public risk sharing, gives hope for the future. Because the matter of the fact is that some public goods, like climate, like energy markets, are simply more efficiently arranged at the European level. Over the years, the euro area has grown from twelve to nineteen countries – and soon twenty. Almost 350 million people live in the EMU. As an economist, it just makes a lot of sense to use the strength in our numbers. To use our strength to achieve shared goals. And to do that, we need to share funds… and also risks. I am an economist, but also a realist. So I am well aware of the political hurdles that must be overcome if we are to increase risk sharing. But looking at what we have achieved so far, I might just be, above all, an optimist. Thirty years ago, the Maastricht Treaty set out a vision. And in the past thirty years, we have witnessed the tremendous economic and political accomplishments of that vision. We are not there yet, the EMU remains a work-in-progress. But let’s keep working on that progress. We have thirty years of experience to learn from. Thirty years of crises and successes, of design flaws and great innovation, of opportunities for reform that we have missed, and opportunities for prosperity gains that we have seized. So let’s learn from these thirty years – politicians, economists, everyone – let’s learn from them and then lift our economic and monetary union to the next level. So, again, happy birthday to the Maastricht Treaty. I’m looking forward to our progress in the next 30 years! Thank you. | netherlands bank | 2,022 | 9 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Netherlands Bank/Official Monetary and Financial Institutions Forum conference on "Moving beyond climate: integrating biodiversity into financial markets", Amsterdam, 29 September 2022. | Speech Klaas Knot - To quagga or not to quagga? Time to restore the balance 29 September 2022 General Read aloud During the DNB - OMFIF conference at Artis Klaas Knot called out for action to prevent biodiversity loss: “Our demand for nature’s goods and services far exceeds our planet’s ability to produce them on a sustainable basis. Now it’s time to restore the balance and save our planet and our economy. The question is: how can and will the financial sector become part of the solution?” "The financial sector has an enormous stake and therefore a crucial role to play in the prevention of biodiversity loss. It is time for the private and public sector to start taking action collectively" Klaas Knot President , De Nederlandsche Bank Date: 29 September 2022 Speaker: Klaas Knot Location: OMFIF conference at Artis, Amsterdam Good morning everyone, This is a quagga (‘kwagga’). Yes, I know, it looks like a horse designed by a committee…. but it is a South African family member of the zebra. And no, you have never seen it before. It was hunted to extinction after the European settlement of South Africa the same food as domesticated animals. , because it ate Some were taken to zoos in Europe, but breeding programmes were unsuccessful. The last quagga died next door, here in Artis, on the 12th of August 1883. At first, people didn’t realise this was not only one animal that was no more, that had ceased to be, that had kicked the bucket. That this quagga was not only as dead as Monty Python’s parrot, but that it was the last of a species a species. But when they did, the poor animal was stuffed and is now a treasured exhibit in Leiden’s Naturalis museum… Artis was a lot more successful in the preservation of the wisent (‘wiezent’), the European bison. A hundred years ago these bison were nearly extinct, but a clever breeding programme made sure there are now thousands of them living happily in European nature reserves. This was a special project of the third director of Artis, Armand Sunier. Artis is involved in a number of similar breeding programmes. This makes Artis not only a place to see and get to know the wonderful richness of nature, but it also means that Artis is contributing to the preservation of nature, of our planet. That it is working to prevent biodiversity loss. And we all know how important that is. That is the reason why you are all here at this conference. Because you all realise that the financial sector has an enormous stake and therefore a crucial role to play in the prevention of biodiversity loss. Because you all have unique knowledge and insights, interesting experiences, facts and figures to share. Because you are all able to make a difference Welcome to you all! I hope this conference will give us new insights and new energy to make sure that we can, and will, play our part to save our planet. That we take our responsibility. We all know that we have no time to waste. Biodiversity is declining faster than ever in human history. Not only some rare species, some quaggas and wisents, but we are talking about one million species that face extinction, possibly within a couple of decades. Around 75% of land and 66% of marine environments have been severely altered. Ecosystems have declined by almost 47% relative to their natural baselines. This will not only affect our planet, our environment, but also our global economy, our way of life. And all this, there is no way to sugar-coat this, is mainly our doing. Our demand for nature’s goods and services far exceeds our planet’s ability to produce them on a sustainable basis. So it’s time to restore the balance, time to save our planet and our economy – and in doing so, save ourselves… Why is this important for the financial sector? How does this affect us? I don’t think it will be news to you that globally, roughly 44 trillion dollars of economic value – more than half of the worlds’ total GDP – is moderately to highly dependent on nature, and therefore exposed to its deterioration. In the Netherlands alone, more than 500 billion euros of the investments of Dutch financial institutions are highly or very highly dependent on one or more ecosystem services. The sector provides loans and other financial services to companies in sectors like agriculture or processed food and drink production, sectors that are dependent on ecosystem services like pollination. But it is not just dependencies that can make companies, and those that invested in them, vulnerable to biodiversity loss. It is also the negative impact of certain companies on nature that create risks. Companies that stimulate deforestation, make excessive use of unrenewable resources and pollute the environment. Companies that contribute to the fragility of nature, and which are the likely targets of policies aimed at restoring it. Investments in such companies create transition risks, and make the financial sector part of the problem. But it is does not have to be this way. Financial institutions are the enablers of economy activity. They have the power, through capital allocation, to guide financial flows away from activities that hurt nature. The question is: how can and will we make sure that we – the broad financial system, from public to private actors – become part of the solution? Studies by the World Bank, the central banks of the Netherlands, France, Malaysia and Mexico and others, and the study by the Network for Greening the Financial System – that is our partnership of 116 central banks and international organisations – recently concluded that biodiversity loss is a source of financial risks and could affect financial stability. Creating awareness, that is step one. g p The second step is the need to understand the problem. Several central banks and supervisors are working on quantifying the problem: measuring the value of natural capital, understanding its relation to economic growth, providing assessments of financial vulnerabilities and building scenarios to create a much needed perspective.. Better disclosures are at the heart of those efforts. After all, information provided by corporate and financial institutions is a key ingredient for better analyses and decision-making. Governments and standard setters have to take a leading role by implementing, improving and harmonising disclosure requirements. Of equal importance are market-led initiatives like the work that is currently being done by the Taskforce on nature-related disclosures (TNFD) These two steps represent what we excel at: collecting and interpreting data. But we have to make sure that our quest for better data does not result in delays. Because it is time – high time – for the third step: to actually take action and use the data at our disposal, to change the way we do things, to restore the balance between nature and economy. As the nitrogen crisis and last year’s floods in the Netherlands show, the loss of biodiversity is not merely a challenge for future generations. Timely action is needed to ensure that we bend the curve in time. Actions to stop the degradation of nature in the short term Actions to move swiftly to an economy that helps to restore nature. This is why I am thrilled that the NGFS does not only acknowledge the relevance of naturerelated risks, but also established a taskforce to make sure these risks are seriously taken into account. As a banker – and to be honest: as a person – I am risk-averse. But uncertainties must not hold us back. Nature – life! – is an uncertainty by definition. We have to live with that… I know, this is not the first time high-level policy makers have come together to discuss biodiversity loss. In fact, international biodiversity targets have been set before. Unfortunately, all signs show that these ambitions and goals have not been met. So let’s talk about our ambitions and goals and targets. Let’s step over our urge to avoid risks to avert the risk of further biodiversity loss, of further irreparable damage to our planet. Let’s put our heads, our minds, our ideas together today to help each other take that very important third step. Let’s talk about sustainable finance and how we can make a change. A real change. Because all beings – animal, mineral and vegetal – have a role, a place, an impact on our planet and our lives. Or, in ‘our’ language: diversification is critical. For asset managers, but also for nature. And let’s be honest, we all know that the extinction of one species would not really disturb our planet’s ecosystem; one species would not really be missed. And that is homo sapiens. I seriously doubt that other species would take the trouble to stuff the last human being and put it in a museum… So instead of being a net negative for this planet, let’s earn our keep! I know we can do it! Just look at the programme. Look at the participants. A rare and impressive collection of esteemed colleagues and brilliant minds, like ECB board member Frank Elderson, the Executive Secretary of the UN for the convention of biological diversity Elizabeth Maruma Mrema, Banque de France governor Francois Villeroy and many other knowledgeable representatives of important organisations like the European Commission, NGO’s, standard-setters, universities, the NGFS, banks and asset managers. Together we can take the next step! | netherlands bank | 2,022 | 9 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Morningstar Investment Conference for Institutional Investors, Amsterdam, 29 September 2022. | Speech Klaas Knot - “Navigating climate-related financial risks” 29 September 2022 “There is no GPS to navigate climate-related risks. The navigation tools are still being developed. But fortunately, progress is being achieved rapidly – and it is up to us to catch the wind in our sails. The FSB Roadmap is an important tool to help us do that.” In his keynote speech at the Morningstar Investment Conference for Institutional Investors, Klaas Knot further elaborated on navigating climate-related financial risks. "Today, our lodestar is probably not a celestial body. It is more likely to be a satellite." Klaas Knot President , De Nederlandsche Bank Date: 29 September 2022 Speaker: Klaas Knot Location: Morningstar Investment Conference for Institutional Investors Hello everyone. It is a pleasure to be here. And from me too: welcome to Amsterdam. The early birds amongst you, or the ones with serious jet lag, might be familiar with it: a bright, star-like light, early in the morning, in the eastern sky, right before sunrise. It is, of course, not a star. It is the planet Venus. Also known as… the morning star. After the moon, it is the brightest celestial body in our night skies. This is why Venus, the morning star, played an important role in navigation at sea – together with other celestial bodies. In the early days, to determine one’s position at sea and subsequently, one’s course, astronavigation meant not just having a reliable lodestar. In practical terms, it required having at one’s disposal a well-established set of tools to gather, analyse and apply the necessary data to stay on course for targets well beyond the horizon. I guess this is not fundamentally different from what the investment community does g y y professionally. The target for many of you is to achieve superior risk adjusted returns. For this you need reliable data and decision-making tools that allow you to incorporate emerging risks and opportunities into your portfolio allocation and risk management early on. An existential threat for humanity at large, and so, also for finance, is the threat of climate change. A threat that moves ever closer. A threat that is global and pervasive. Physical risks may affect the value of a broad range of financial assets in ways that are hard to predict. And the transition to net zero, though it offers a wealth of opportunities -- also comes with its own risks. Current discussions of energy policies in the face of rising fuel prices have demonstrated the difficulties in identifying and pursuing a sustainable course forward. So, what is needed to give the private sector the means to navigate the challenges of climate change? I will try to provide an answer by discussing three specific questions. First, what data and tools do financial institutions, including asset managers, need to properly manage financial risks from climate change? Second, what needs to be done to ensure the stability of the financial system as a whole amidst climate change? And third, against this background, what does effective cooperation on financial risks from climate change look like, not least between the private and the public sectors? I will discuss these issues, using the Financial Stability Board’s (FSB) work in this area as a reference point. Concretely, I will refer to the FSB’s Roadmap to address financial risks from climate change. This roadmap, which G20 Leaders endorsed in October 2021, has the ultimate goal that climate risk is adequately reflected in all financial decisions – precisely what is needed to successfully navigate the financial aspects of climate change. Let me start with the firm-level – or micro – perspective. The basis for good risk management is good data. Climate risk is no different. Recognising this, the FSB has long championed the need for investors, lenders, insurers and others to have access to the information they need to understand and manage climate risks, but equally, to seize opportunities stemming from climate change. The FSB’s Task Force on Climate-related Financial Disclosures (TCFD) was established in 2015. It has led the charge in developing effective climate-related disclosures that promote better informed credit, investment and insurance underwriting decisions. The TCFD’s work has gained enormous traction over the years. More than 3,000 companies from 92 countries are TCFD supporters, representing a combined market capitalisation of 27 trillion US dollars. And most FSB jurisdictions either require or encourage disclosures that use the TCFD Recommendations as a basis. But now we are moving to the next level - a global baseline standard that can build on the TCFD framework with more granularity and standardisation. This is where the International Sustainability Standards Board (ISSB) comes in. Establishing a global baseline y ( ) g g standard for sustainability reporting – starting with climate – is important for promoting convergence of approaches, as well as consistency and comparability of firms’ disclosures across the globe. The ISSB has been consulting on its two draft standards, respectively on general sustainability-related financial information and on climate-related disclosures. This marks an important milestone in the push towards establishing a common global baseline for jurisdictional requirements. Once finalised, it will be important that jurisdictions take early action to adopt, implement or otherwise make use of the standards. Some jurisdictions will want to go further than others in their requirements. But interoperability, using a common baseline as developed by the ISSB, can help avoid harmful fragmentation. This baseline ensures that disclosures can be made on a common basis, enabling users to compare and aggregate exposures across jurisdictions. While these new standards are being finalised and implemented, the FSB continues to encourage jurisdictions that are implementing frameworks to base them on the TCFD. The FSB has also asked the TCFD to continue its work to promote and monitor progress in firms’ take-up of its recommendations. It will publish a further status report in October. Globally consistent and comparable disclosures will enable better financial decisionmaking. Such disclosures will also include information on the progress firms are making towards their transition to net zero, and their transition plans to complete the job. This will help all stakeholders to assess the credibility of private sector commitment and action towards addressing climate change. It will, therefore, be important to ensure that these disclosures are reliable. Talking about disclosures, I cannot avoid the topic of greenwashing. There is rightful concern over the scope for greenwashing – concern that will need to be addressed. And not just as a question of proper conduct. Because widespread greenwashing risks undermining efforts to promote and mobilise sustainable finance. I welcome the work by the International Auditing and Assurance Standards Board (IAASB) and the International Ethics Standards Board for Accountants (IESBA) to develop baseline global standards for assurance, ethics and independence on sustainability reporting. The International Organization of Securities Commissions (IOSCO), in its turn, has outlined recommendations to promote greater transparency. It has also encouraged all voluntary standard-setting bodies and industry associations operating in financial markets, to promote good practices among their members. This way, it wants to address the risk of greenwashing at the asset management and product levels. All these initiatives will enhance the confidence of users about mainstream, general-purpose reporting of sustainability information. Let me now turn to my second question: what needs to be done to ensure the stability of the financial system as a whole amidst climate change? Strong risk management at the firm level is a necessary condition for preserving financial stability amidst climate change. But it may not be sufficient. Climate-related risks are broad, but correlated. This means that they could crystalise across multiple jurisdictions and sectors simultaneously, think of the drought, heatwaves and wildfires all over Europe during the course of the summer. Such widespread climate events can have implications for the resilience of the broader financial system. Manifestations of climate risk may give rise to abrupt increases in risk premia across a wide range of assets. This could alter asset price movements or co-movements across sectors and jurisdictions; amplifying credit, liquidity and counterparty risks; and raising challenges for financial risk management in ways that are hard to predict. To address both risks to individual entities and those to the system as a whole, we need actions that are both bottom-up and top-down. Developing such a top-down, or system-wide, perspective faces a couple of significant challenges. The first is data gaps. Firm-level disclosures are an important contribution to closing such gaps, but do not provide all the information needed to gauge climate risks and translate those into financial exposures. We need to make use of the data already available to devise simpler indicators that can help identify the build-up of vulnerabilities, and not wait until we have the perfect data set. And, considering the uncertainty about how risks from climate change will materialize, it is critical to further develop scenario analysis, making use of the common Network for Greening the Financial System (NGFS) climate scenarios. A related challenge is to integrate climate risks into broader financial stability surveillance. This requires not only an understanding of climate-related vulnerabilities in different parts of the financial sector and relevant transmission channels. It also requires data and models to assess potential impacts across the system as a whole. In this regard, data repositories that provide open access to data in a consistent form should be promoted, as a public good. Such information will support the provision of sustainable finance and ensure the proper functioning of the financial system. Scenario analysis is a key tool for assessing financial vulnerabilities. The FSB is working jointly with the NGFS on the use of effective scenario analysis by jurisdictions and on the financial metrics needed for this analysis. In November, we will publish a report synthesising outputs of scenario analyses done by jurisdictions so far. It will then be critical to feed these experiences, with the analysis of climate-related vulnerabilities, into identifying the most critical data gaps and data collection, so that steps can be taken to fill those gaps. This includes data that can translate climate targets, and the transitions to low-carbon economies, into financial impacts. In the near term, our work is focusing on data gaps from the perspective of supervisors and policymakers. But I hope that the findings will also help to improve data about current and forward-looking risks for you, as investment managers. Finally, there is the question of whether there is a need for a dedicated macroprudential policy approach to climate risk. Microprudential tools alone may not sufficiently address climate-related risks, given the cross-sectoral, cross-border and systemic implications. This discussion is just beginning. The FSB encourages authorities and standard-setting bodies to undertake research and analysis on possible enhancements to their regulatory and supervisory frameworks. From all that I have said so far, the critical role of close cooperation and coordination should be obvious. This includes between public sector authorities, and between the public and the private sector, both domestically and internationally. The form and intensity of that cooperation depend on the specific issue at hand. In the area of disclosures, for instance, the public sector is, through the ISSB and other initiatives, building on the TCFD work, led by the private-sector. In an area like surveillance, it is more natural that financial stability authorities with their system-wide perspective take the lead. Moreover, the interaction between private and public sectors will evolve as we make progress towards our common goal – standardization of reporting. The ISSB’s standards will provide a good starting point for the development of standardised regulatory reporting requirements by supervisors and regulators. Such information will also provide supervisors and regulators with the insights, in a common format, they need to understand the implications for systemic risk. And to build the necessary regulatory tools to address this. There is a lot of work to be done and a pressing need to move forward. Coordination on regulatory approaches will be key. A number of international initiatives have been completed or are well underway. These include supervisory risk management expectations and supervisory guidance covering the banking, insurance and asset management sectors. IOSCO’s November 2021 Recommendations on Sustainability-Related Practices, Policies, Procedures and Disclosure in Asset Management set out areas for regulators and policymakers to take forward in this sector. The FSB has responded in a coherent and coordinated way to the challenge of moving forward on a global level. In our Roadmap to address financial risks from climate change, we have covered disclosures, data, surveillance, and regulatory and supervisory policy, and we have brought together the actions of different international bodies into a single plan. Today, our lodestar is probably not a celestial body. It is more likely to be a satellite. And with a mere push on a button, this satellite gives you your exact location and thus the way to your destination. Unfortunately, there is no GPS to navigate climate-related risks. The navigation tools are still being developed. But fortunately, progress is being achieved rapidly – and it is up to us to catch the wind in our sails. The FSB Roadmap is an important tool to help us do that. Through the Roadmap the FSB is providing a forum for discussing cross-sectoral and systemic issues. We are also helping to identify gaps that need to be covered, in some cases by financial market participants and in some cases elsewhere. More broadly, the Roadmap sets out where agreement on a coordinated approach has been reached, and where it still needs to be reached, and the pp way to achieve this. Like sailing a ship, this needs to be a communal effort. The financial community – and investors in particular – also have a key part to play in achieving an orderly transition. When humans first set out for open sea, calculating one’s position had a large margin of error – nevertheless, they set out anyway. And in doing so, those brave early-day explorers mapped out the very planet we call home. Today, we know almost every corner of our earthly habitat. And again we are faced with the question: shall we explore unfamiliar terrain and accept a margin of error? Shall we accept uncertain outcomes, but, in doing so, help preserve our lives and livelihoods? Or shall we wait for the perfect data and run the risk of being too late? I say the choice is obvious. I say, let’s not wait on perfection – let’s work with what we do know, set course and adjust our sails along the way. Thank you. | netherlands bank | 2,022 | 9 |
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Banking Seminar in the Amsterdam Hermitage, Amsterdam, 10 November 2022. | Steven Maijoor: Into the unknown - decision-making in uncertain times Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Banking Seminar in the Amsterdam Hermitage, Amsterdam, 10 November 2022. *** Hello everyone. For years, this museum showcased paintings and sculptures from the expansive collection of the Hermitage in Saint Petersburg. On March 3rd, 2022, one week after Russia's invasion of Ukraine, the Amsterdam Hermitage decided to end that cooperation. Unexpectedly, world events interfered with the museum's course of action. Unexpectedly, the museum had to deal with a scenario it did not foresee. And unexpectedly, the museum's future became clouded by uncertainties. We, as policy-makers, supervisors and banking professionals, are used to dealing with uncertainty. Over the years, we have developed methods, models and measures to deal with it. To a large extent, our institutions, frameworks and decision-making, either implicitly or explicitly, rely on stochastic models. And we know that every model comes with limitations and assumptions. And that we should be aware of them. Because in these limitations and assumptions lie potential risks. Risks that lie beyond the models' perimeter. Today, just like this museum, we are faced with an unexpected level of uncertainty. So today, we find ourselves dealing with factors that lie beyond our models' perimeter. We do not have a straightforward scenario to deal with the extraordinary inflation shock, sharply higher interest rates, and the significant slowdown of economic growth. Today, it is hard to predict where risks will manifest and materialise. But no matter how uncertain the future economic conditions are, at this point it is fair to say that banks' net interest income and credit losses will be affected. First, a word about net interest income. With the tightening stance of the ECB, the Federal Reserve, and other central banks, we see market rates rising. The banking sector may welcome this structural shift in the interest rate environment. The challenges of running a bank in an environment with a flat yield curve, negative interest rates, and fierce yield competition, have finally eased. We have observed the positive effects of the ECB's tightening stance on interest rate margins as deposit rates have remained around zero percent and lending rates have increased in parallel with market rates. Case in point: the annual growth of net interest income accelerated to thirteen percent in the second quarter of 2022, from five percent in the first quarter.1 1/4 BIS - Central bankers' speeches Although the rise in interest rates may be welcomed by the banks, it may also introduce potential risks. With the current uncertain inflation and geopolitical outlook, further strong and rapid interest rates hikes cannot be ruled out. Just look at the rapid pace at which the Federal Reserve has been increasing rates in the US. In such a scenario, banks' assumptions regarding the interest rate sensitivity of deposit funding and the prepayment behaviour of mortgage customers will be tested. Furthermore, we are observing a deterioration of funding conditions with increasing credit spreads on market funding and TLTRO funding that needs to be repaid. This might have two effects. First, it might directly put downward pressure on banks' net interest income. Second, it might indirectly increase the competition for deposits. This illustrates that, in the times ahead, a deep understanding of the dynamics in interest rate management, and of the underlying assumptions, will be crucial for banks, but also for us as supervisors. Next, a word about credit losses. Since the invasion of Ukraine, financial institutions have had to absorb credit losses on their exposures to Russian, Ukrainian and energy-intensive businesses. Looking ahead, uncertainty dominates the economic outlook: the so-called secondorder effects of macro-economic developments on banks are difficult to anticipate or to quantify. The inflationary shock will have large and diverse income effects. On top of that, the tightening of monetary policy will increase real interest rates, and this will almost inevitably lead to lower real economic growth, and thus negatively affect banks' customers, and their ability to pay their loans. Looking at the European housing market in particular, we see that it has been cooling off for several months. Higher mortgage rates and a loss of household purchasing power can lead to lower lending growth and an increase in household defaults. And as a result, credit losses for banks on mortgage loans might increase. Challenging times lie ahead for the corporate sector, too, especially for those corporates that are not able to adjust to the energy shock, and those that operate in cyclical sectors or in sectors that are sensitive to funding risks. A particular example of these funding risks are the risks that have accumulated as a consequence of the search for yield during the prolonged period of low interest rates. The leveraged finance portfolios of banks have expanded in recent years and their quality could quickly deteriorate when corporate earnings decrease. What makes the current economic situation extra challenging is that external shocks, like the ones we are experiencing today, might take time to fully materialise. We learned this from the two oil crises in the 1970s. The oil shocks in 1973 and 1979 led to an increase in banking provisions that only peaked in 1983. And those provisions were even higher than the provisions during the great financial crisis. 2/4 BIS - Central bankers' speeches So when and how the current inflationary shocks will have fully rippled through our economy is highly unpredictable. This will also depend on the fiscal and monetary policy response, and whether or not the geopolitical situation deteriorates further. So now that we find ourselves beyond our models' perimeter and without a straightforward scenario at hand, how do we go forward? What can guide our decisions? I suggest three "lines of defence": First, in order to enhance banks' resilience, the implementation of Basel III in Europe should continue without delay and with as little deviation as possible. One of the cornerstones of the Basel III reform is the introduction of the output floor, which is designed to reduce model risk. In this specific case, model risk is the risk that a bank's internal models incorrectly estimate the bank's capital requirements. For banks, the output floor will put a limit on the reliance on stochastic scenarios and increase their resilience. On this matter, I fully support the strong plea from the ECB and the EBA to faithfully implement Basel III.2 Second, for banks to be able to determine their course of action and assess and mitigate risks, they need a thorough understanding of their exposures and of how the current challenges might impact their portfolios and financial positions. This starts with good data of high quality and extensive insight into their customers' financial positions – not only at the start of a contract, but also throughout. That is why we put pressure on banks to improve their data quality, and to properly aggregate and report on their data. Third, whatever scenario banks eventually follow, it is crucial to maintain a healthy capital position. As I briefly illustrated with the oil crises, many of the risks of the current circumstances may only materialise down the road. The economic and financial situation in which banks took on risks on their balance sheets in the past years has fundamentally and abruptly changed. This makes it very unlikely that the scenarios used then still align with the world of today. This is why we are asking banks to be prudent with dividend payouts and share buybacks, and to take into account the potential increase in credit losses, and other risks, and what this might mean for their capital position. That being said, I fully recognise the importance of access to the capital markets for banks and the role played by cash distributions. This is why, as a supervisor, I favour a careful, case-by-case approach when it comes to dividend payouts and share buybacks, especially taking into account the differences in each bank's vulnerability to downward economic pressures. Banks are in a good starting position for these three "lines of defences". Over the last 15 years, banks have worked hard on improving their balance sheets, on cleaning up nonperforming loans, and on building up robust capital and liquidity buffers. Consequently, they are well-equipped to weather the current uncertain and challenging times. With average CET1 ratios around 15 percent in Europe, banks' capital ratios were at similar robust levels in the second quarter of this year as in the first quarter. Moreover, their liquidity coverage ratio stood at 165 percent in the second quarter of 2022.3 3/4 BIS - Central bankers' speeches And the Single Supervisory Mechanism (SSM) has played a key role in this process of improving banks' balance sheets. The SSM has boosted the quality of supervision, internalised and addressed coordination problems between national banking supervisors, and centralised data reporting and information sharing. These advancements, which have contributed to the building of the European Banking Union, are also recognised in the revision of the Basel buffer methodology for global systemically important banks. All of this has taken a tremendous amount of work. 15 years ago, the Amsterdam Hermitage was a care home – as it had been for a few centuries. After an impressive two-year renovation, the care home was transformed into the current state-of-the-art museum, which opened to the public in 2009. To remain the state-of-the-art museum that it is today, the Amsterdam Hermitage will need to be the opposite of what its name suggests. Though it is called Hermitage, it must avoid any kind of hermitic stance. The same goes for us. As banking supervisors, we cannot be hermits either. We must also face outwards, not inwards. We must also explore scenarios beyond the usual ones to weather the uncertain times. And no matter what way forward we choose, we must work together, within the SSM, and maintain an open dialogue with the sector to help shape, and implement, our supervision. This is why, after a three-year break, we are happy to be organising the Banking Seminar again. It offers a great opportunity to come together and discuss the challenges facing the banking sector. Thank you. 1 Based on a sample of 20 European banks. 2 https://www.bankingsupervision.europa.eu/press/blog/2022/html/ssm. blog221104~52d1c3a8e1.en.html 3 According to EBA Dashboard Q2 2022. 4/4 BIS - Central bankers' speeches | netherlands bank | 2,022 | 11 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the 25th Annual DNB Research Conference "Inflation strikes back: drivers and policy reactions", Amsterdam, 10 November 2022. | Klaas Knot: Inflation strikes back - drivers and policy reactions Speech by Mr Klaas Knot, President of the Netherlands Bank, at the 25th Annual DNB Research Conference "Inflation strikes back: drivers and policy reactions", Amsterdam, 10 November 2022. *** Welcome everyone! This is a sight for sore eyes: a whole room full of real-life delegates! A posse of bankers, a pride of economists, a pack of scientists. Or whatever the proper collective noun would be for a gathering like this-I only know we are a collective. Because we share an interest, a passion, a purpose: we are interested in economic developments. My interest in economics was triggered by the great inflation of the 1970s. I remember my parents' distress about exploding mortgage costs, the fuel coupons, the empty roads on Sundays, our concerned prime minister on television warning us that nothing would ever be the same againAnd I wondered: how on earth could this happen? And, what could be done? How can we prevent this from happening again? So I studied economics, I worked in public policy, I became a central banker. And I learned that economics is not a selfcontained science, there is never one right answer that stays right forever, like in a hard science such as mathematics. As John Maynard Keynes one said: "The master-economist must possess a rare combination of gifts. He must reach a high standard in several different directions and must combine talents not often found together. He must be mathematician, historian, statesman, philosopher - in some degree. He must contemplate the particular in terms of the general, and touch abstract and concrete in the same flight of thought." That is our challenge: to come up with different ideas, combining different talents and different perspectives, in response to the problems of our times. With a big advantage of our time: economists are not only 'he' anymoreComing up with ideas, that is what we, what you, will do during this conference. In answer to the problem of today, because inflation is back. With a vengeance. Last October HICP inflation reached 10.7 percent, with some heterogeneity among euro area countries. Here in the Netherlands we are experiencing a 16.8 annual percentage change in the overall level of prices. Like in the 1970s, the current high inflation is rooted in energy price shocks, this time as a result of the war in Ukraine. However, recent analyses show that supply factors alone cannot explain the very high figures we are observing today. Core inflation is also on the rise, having reached 5.0 percent in October. 1/3 BIS - Central bankers' speeches Intuitively, both the slow recovery from supply chain bottlenecks and the extraordinary increases in energy prices have a negative impact on the real economy. So if they were the only drivers of the current high inflation, we would have seen a drop in production in the first half of the year. But we do not find this drop in the data, suggesting that demand factors must also play a role. The question is: which factors in particular? Let me suggest a couple of candidates: the relaxation of COVID restrictions and the fiscal policy of our governments. A fiscal policy that boosted demand in the aftermath of the pandemic, designed to counteract the negative effects of the lockdowns. A fiscal policy that is now being called upon to compensate our energy bills. That question - how much of the current inflation can be attributed to fiscal measures - is a topic of this morning's discussion. This interaction between monetary and fiscal policy is just one aspect of the complexity of the policy reaction to the current situation. Because that's what it is: very complex. As I said: in economics, in monetary policy, there is never one answer. Conducting monetary policy requires a deep understanding of the drivers of inflation. And that understanding is constantly tested by reality. By events. According to British Prime Minister Harold McMillan, this is the greatest challenge for a statesman. And the greatest challenge for an economist and a central banker. After the 1970s we enjoyed a long period of stable prices: inflation was under control and we thought we had that deep understanding of its drivers and dynamics. Then the financial crisis challenged our confidence, followed by a period of persistently low inflation, and now we have been surprised again. By the persistence of inflation dynamics, and skyrocketing prices. Price dynamics are more complex than we thought: events are wreaking havoc on our numbers, our models, our data. We see that the models we use in our analyses very often struggle to capture the persistence of inflation dynamics in a satisfactory way. Is it possible that the economy is becoming more vulnerable to systemic shocks? Are the after-effects of these shocks more persistent than we expected? Do we underestimate the longer term impact of supply-driven shocks? It is obvious that the structure of the economy today is different than it was fifteen, let alone fifty, years ago, so it is possible that the transmission mechanism of inflation shocks might be different. The question is: does this uncertainty imply that policy-makers should react strongly to these kind of shocks? Act faster, intervene earlier to avoid the dangerous fall-out of inflation? Of course there is one big difference between inflation now and in the 1970s: we now have the euro, a crucial pillar of financial stability that stands between us and a currency crisis. The challenge is clear: if we want to understand the recent developments of price changes, if we want to understand and fight inflation, we need to understand and pinpoint the transmission mechanisms of inflation shocks. During this conference, the discussion will touch on essential topics like the role of heterogeneity in sectors, the implication of firms dynamics, the amplification effects that derive from uncertainty. 2/3 BIS - Central bankers' speeches The following questions are also on our research agenda at DNB: how can we enhance our understanding of inflation expectations, of how they are formed, and how they evolve over time? The answers to these questions are crucial. As Keynes also said when he described the tasks of the economist: "He must study the present in the light of the past for the purposes of the future." Also on our agenda, and also crucial for 'the purpose of the future' is the role of long-run trends and the normative implications that arise from low or even negative natural rates. Yes, there is work to be done. We must 'study the present' to understand the normative implications and to guide the practical implementation of monetary policy. And although fighting inflation – in Europe and the US – is our common goal, let's not forget that there are differences in the economic developments in our countries and on our continents. Differences that justify some diversity in the policy reaction of the different authorities: a very interesting topic to be discussed in the policy panel later today. You may have heard the saying: Ask five economist a question, and you get five different answers – six if one went to Harvard... The fact that we do not always agree is often used against us. It is also used as a reason to doubt that economics is a real science. But what some people see as our weakness, I consider a strength of social sciences. Yes, we have different opinions, we have debates and discussions, but that is part of the challenge. As Keynes concluded his description of the tasks of economists: "No part of man's nature or his institutions must lie entirely outside his regard. He must be purposeful and disinterested in a simultaneous mood; as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician." Yes, economics is not only a science, but an art. The art of thinking outside the box, the art of finding solutions. Of finding new ideas to face up to today's economic problems, to fight inflation. I wish you two very artistic days! 3/3 BIS - Central bankers' speeches | netherlands bank | 2,022 | 11 |
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the 6th edition of "FinTech meets the Regulators", organised by the Netherlands Bank and Holland Fintech, Amsterdam, 1 June 2022. | Steven Maijoor: Data make the world go round - on open data and open finance Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the 6th edition of "FinTech meets the Regulators", organised by the Netherlands Bank and Holland Fintech, Amsterdam, 1 June 2022. *** Hello everyone. A month ago the European Commission issued a complaint against Apple. The commission accused the tech giant of restricting competition in the mobile wallet market by restricting access to near-field communication, commonly referred to as tap and go. The Commission stated that Apple "abused its dominant position in markets for mobile wallets on iOS devices. This has an exclusionary effect on competitors and leads to less innovation and less choice for consumers for mobile wallets on iPhones". A very interesting case. A case that includes and highlights the issues we will be talking about today; innovation, data sharing, level playing fields and the costs and benefits of technological innovation. Especially the data that are sourced, accumulated and shared by these innovations. Because we all know: data make the world go round-. The financial sector is no exception to this trend: the need for data in all forms and from all sources. Those data are essential to innovate financial products and financial processes. To enable financial institutions to offer cheaper, faster and more personalised services. To increase efficiency and economic growth. But to reap all these benefits it has to be possible for consumers and businesses to share their data in a way that safeguards their interests and enables innovation, efficiency and competition. We have to take open banking one step further into what we call open finance. Open finance goes beyond the scope of data and services available at banks, covering not only payment data, but also data on investments, savings, loans, and insurance, such as claim history. Data that can be used to help financial institutions to make better estimates about risks, because they gain access to the total financial footprint of their users. Data that can be shared with other financial parties, including FinTechs and other third parties. Under open finance this sharing of data will be based on permission from the data owner, just like with open banking, now regulated by PSD2. Open finance is a big step. A welcome step. DNB is also taking a first step in making data that we have as a supervisor, available to financial parties. For example, DNB is actively participating in an initiative for a Credit Register for companies, in which data from our reports on the status of corporate loans 1/3 BIS - Central bankers' speeches are made available to the sector. To banks, but in the future also to credit rating agencies, alternative financiers and other third parties. We will also investigate if, and under what conditions, we can share other available data. Yes, open finance is an interesting step, that provides interesting opportunities. But it is also a step that is and cannot be without consequences, without questions that have to be raised and answered. Fundamental questions about possibilities and opportunities, about rights and wrongs, about artificial intelligence and the safety, stability and accessibility of our financial system. This meeting is to do exactly that: raising and answering questions. And the best way to do that is with all the parties involved: regulators, supervised institutions – such as banks, insurers and pension funds – and other key players such as startups, vendors, consultants and academics. I welcome you all here today at the 6th edition of 'Fintech meets the regulators'. Not on screen but – for most of you - onsite; I am sure that will make the dialogue and discussion more dynamic. Because a spirited dialogue is what we need in order to do what we have to do: create a thriving financial ecosystem that is both innovative and safe, both open and regulated. Yes, that sounds like a contradiction. But it is not. Not in the financial world we operate in. Because our financial sector is firmly supervised and regulated. Those rules and regulations, supervisors and regulators are there for a reason; to protect consumers, to ensure a sound and stable financial system, to support our economy. Every player, old and new, financial institution and third party, has to play by the rules. But that doesn't mean that these rules are written in stone. They can evolve, they can even be written in the Cloud, but they have to be there. Because we have to protect our financial system and ensure financial stability. DNB aims to be a 'smart supervisor': a data driven supervisor using the latest technologies to make supervision better and faster, while keeping direct and indirect costs at an acceptable level. In a close dialogue with the sector. That is why we have set up the iForum, a platform for initiatives where technology and supervision meet. You will hear more about iForum during the second part of this event. To be able to be a smart supervisor it is important to understand the possibilities and challenges of new technologies. That is why explainable AI is also one of the topics of this meeting. To understand our obligations – as financial institutions and as regulators - we need a solid and practical framework regarding explainable AI, and the knowhow to make that work. That is one of the challenges we face to make open finance work. For us and for our consumers. For DNB and AFM that means we have to take our responsibility to regulate these new developments: next to our supervision of PSD2, we will likely be tasked with the 2/3 BIS - Central bankers' speeches supervision of open finance, and that will have consequences for our mandates. We have to ensure the protection of interests of data holders, to enable data-related innovation, to create a data level playing field. It is obvious that open finance will not be a national issue. Data make the world go round, but never stop at borders- That is why the European Commission is working on rules to regulate the European and international consequences of data mobility. That is the drive behind the Digital Markets Act, the European Data Act and the Data Governance Act. This year we also expect the Commission proposal for Open Finance. These proposals will extend the possibility of automated sharing of financial data with third parties from PSD2 to other forms of financial data. They will also make nontraditional, non-financial data available to financial institutions. Think of BigTech data, data generated by your FitBit or by your car. These initiatives are very important to shape and regulate open finance. We will not sit quietly in the meantime: together with the AFM we will publish a Discussion Paper with our vision on data mobility. This Discussion Paper will look at why regulating data sharing and data mobility is needed. We cannot afford to be blinded by the opportunities open finance and data mobility will offer. Data concentration is a real risk: as we shared in last year's BigTech-report, there can for instance be a risk to financial stability if and when data are concentrated in Big Tech companies. A risk that can result in market failures in data markets, especially when sharing collides with privacy, when data are shared without the knowledge or assent of the data owner, or when the data owner does not realise the consequences of data sharing. The Discussion Paper will look at these market failures, and set a vision for data mobility to be organized in such a way that the benefits to innovation can be reaped, but the risks and market failures are sufficiently mitigated. It will look at how the consumer's interests can be safeguarded, how we can create a fair 'data playing field' for all financial entities, and consider the role we as financial supervisors can play. But most importantly, it will aim to start a dialogue with all of you, on this important topic. Because, yes, data make the world go round. Yes, open finance has our attention. Because we are the modern-day cartographers of this uncharted territory. Of course there will be dragons. But it is our ambition and our challenge to slay those dragons before we meet them. Let's go to work! 3/3 BIS - Central bankers' speeches | netherlands bank | 2,022 | 11 |
Speech by Mr Olaf Sleijpen, Executive Board Member of Monetary Affairs and Financial Stability of the Netherlands Bank, at the Inspire2Live Annual Congress, Amsterdam, 14 September 2022. | Olaf Sleijpen: Embracing a healthy economy Speech by Mr Olaf Sleijpen, Executive Board Member of Monetary Affairs and Financial Stability of the Netherlands Bank, at the Inspire2Live Annual Congress, Amsterdam, 14 September 2022. *** "Hi, I am Olaf, and I like warm hugs." For those of you with children, or grandchildren, or for those of you who work with children, this will sound familiar. In the Disney movie Frozen, set in a snowy, northern country, two sisters, Anna and Elsa, make a snowman and call him Olaf. He is a muchneeded friend for them. And their enthusiasm, love and human warmth- inspire him to live. And at a certain point in the movie, he, in turn, saves Anna's life from the cold winter. The first time I heard about Olaf – I was, of course, intrigued, given that we share a name. But then something else struck me. Introducing himself, he doesn't just say his name – he adds what he finds important. And it doesn't matter that he is a snowman – and warmth and snow usually don't go well together. 1. Why am I telling you this? Because I am Olaf. Because during the pandemic, I missed human contact and realised how important it is for me – and for most of us. Because it is important to talk about what you find important – about what keeps you going – about what inspires you- and ultimately, what inspires you to live. Because it is important to be heard. Especially when you are diagnosed with cancer – and the ground collapses under your feet. Before I start my speech, I would first like to thank you for offering me the opportunity to be here today. To be the first speaker on this special day, special for you and for your important work. Thank you. 2. Opening Inspire2Live's conference The fact that I am here today, as an executive board member of De Nederlandsche Bank, as an economist and as a professor, in this magnificent room in the Royal Netherlands Academy of Arts and Sciences, is the result of an encounter twenty-two years ago. In 2011, the then president of the Academy, Robbert Dijkgraaf met the then president of De Nederlandsche Bank, Nout Wellink. Together they decided to support Inspire2Live in a number of ways. And one of the results of their decision is that our organisations have been facilitating the Inspire2Live Conferences for twelve years now – with a two-year interruption due to CovidA second parallel between my world and yours, dear guests, is also quite obvious. I'm looking at an international company of highly trained professionals, who cooperate 1/4 BIS - Central bankers' speeches across several borders to serve a societal goal. Like your work, our work also has a societal goal and requires international cooperation. We share insights, raise questions and engage in debate with our colleagues from the eurozone, and on a wider scale with those from the Worldbank, the IMF and many other international organisations. And like you, we prefer to debate on the basis of evidence. Scientific evidence. Just like cancer research is the most fruitful when it can profit from cooperation of many researchers like you, from all over the world, just so our mission of stable financial institutions and sustainable welfare profits from international scientific cooperation. These parallels in your and our work, make me feel slightly less overwhelmed, standing in this stately hall filled with so many eminent academics. A third parallel is related to the substance of our work, of your work and mine. This is the parallel I would like to turn into the main subject of this opening speech. Your subject of study - the treatment and prevention of cancer - has an economic value in addition to its intrinsic value. A healthy economy benefits from a healthy population. The past two years we have seen that the reverse is also true: a population suffering from a pandemic will suffer from economic consequences - Not that I expect that you are eager to listen to a professor of economics telling you that your work is essential 'because of its economic value'- Your work is intrinsically essential of course. And here I would again like to thank you all, for your collective and unbridled commitment to global healthcare. With this speech I would like to try to substantiate this 'thank you'. 3. Why and how does a central bank take health into account? Our core task as a central bank is – as I mentioned earlier - to contribute to financial stability and sustainable welfare for all Dutch citizens. Although there obviously is a relationship between economy and health, we must admit we cannot quantify or clearly specify this. But we did learn some things from the pandemic. Central banks and other institutions have found a way of dealing with uncertainties by developing alternative economic scenarios. These scenarios tell us more about uncertainties stemming from non-economic developments. Uncertainties like climate change, like the pandemic and like the war in Ukraine. But recently, we also found some hard evidence. 4. Economic impact of the pandemic The income of most workers in the Netherlands remained stable throughout 2020, or even increased a little. But there was also a large group who saw their income fall. In the first year of the COVID-19 pandemic, 130.000 more people than in 2019 experienced a drop in income of 10 percent or more. Most of these were flexible workers and self-employed people. The flexible workers in particular risked losing their source of income – while at the same time they had smaller financial buffers to neutralise the consequences. Looking back, we seem to have overestimated the economic consequences of the pandemic. The government's support measures functioned as a cushion. And what's more, the economy itself adapted to the situation more rapidly than expected. This 2/4 BIS - Central bankers' speeches economic resilience came as a surprise to us. At the moment, the Dutch economy has grown by almost 6% compared to the eve of the pandemic, near the end of 2019. For the euro area this was almost 2%. Next to the direct decline in income and the rapid economic recovery, we have seen some other consequences that have a direct impact on the economy. The COVID-19 crisis has reinforced already existing inequalities: we have clearly seen there is a direct relationship between a country's vaccination rate and its GDP. So, full recovery can only be realised when the vaccination coverage in less developed countries has reached the same level as in more developed countries. And here our fields of work touch once again - a global vaccination campaign will also prevent new, more agressive variants of the virus. 5. Vaccination policy affects the economy Vaccination policy is now also economic policy. We have seen that countries with higher rates of vaccine coverage have also been able to recover faster from the economic disruption caused by COVID-19, while low vaccination rates have contributed to a drag on recovery elsewhere. Increasing vaccination levels will help drive a sustainable global economic recovery. Reducing the impact of COVID-19 on health systems will also allow countries to return to other crucial health and economic priorities at a time of great global insecurity. And if the world or parts of the world find themselves in a severe downside scenario, then there will be significantly higher health and economic returns from a higher vaccine coverage. High and upper-middle income countries have been able to reach high vaccine coverage across their populations, surpassing global targets. Early this year, 70% of the population of G20 countries have now been fully vaccinated. Unfortunately, while progress has been made, the delivery of COVID-19 vaccines against global targets remains unequal and falls short of the expectations. 6. Differences in economies Currently, around 50% of announced vaccine donations by high-income countries have been delivered to low-income countries. Although the acute impact of the COVID-19 pandemic now seems to be fading in most parts of the world, there is still an opportunity to minimise the cost of having to live with the virus. About 130 countries failed to meet the IMF's vaccination target of 70% by mid2022- Similar inequalities persist in terms of access to tests and treatments. Universal vaccination, according to the IMF, remains the best shield against new variants and persistent health-related absenteeism. And this universal vaccination should be backed by broad public health campaigns to promote vaccine uptake. The IMF continues: "Governments should also intensify efforts to resolve vaccine supply and distribution bottlenecks and ensure equitable access to treatment. Public support for better systematic responses to future epidemics and research into new vaccine technologies, including for a more widely effective pan-coronavirus vaccine, remains essential." 3/4 BIS - Central bankers' speeches 7. Role of prevention for the economy In the Netherlands, like in all other developed western countries, the current healthcare system is under immense pressure. Challenging choices must be made to ensure a viable healthcare system in terms of funding, staffing and political backup. We expect a shift in focus from care to prevention and to sectors where quality and accessibility have been most under pressure in the past few years. Preventive intervention will be needed, which can consist of the obvious, like preventive screening, vaccins or lifestyle campaigns. Albeit important, prevention measures could also be expanded to include housing, food programmes, help with indebtedness, education and environmental policy. Making better choices now means that we must implement those interventions that will improve our health. This will not only benefit our public health as a whole, but also specifically support people with a lower socioeconomic status. Broad prevention programmes tend to be harder to get off the ground, for example because the positive effects of such programmes often benefit other actors than the ones investing in it. Another reason is that the effects of preventive programmes only become clear in the longer term. And a third challenge is the static and often diffuse nature of these positive effects. Not an engaging perspective for a politician in election time... As I said, there are many factors that influence the complicated relationship between the economy and our health. 8. Concluding Ladies and gentlemen. A strong economy greatly benefits from a healthy population. A less healthy population will lead tot higher economic costs – as we saw during the COVID-19 pandemic. And the effect is mutual: our health is influenced by the state of the economy. But housing, the quality of work, environmental conditions, educational level and other societal factors are more determining for our health than healtcare ... So a well-considered package of government policies will strongly add to prevention and, consequently, to a healthy society and economy. So, dear professionals in the field of health, cure and prevention, Keep researching. Keep finding new treatments. Keep finding hope. Keep inspiring many to live. But don't forget the warm hugs. Thank you. 4/4 BIS - Central bankers' speeches | netherlands bank | 2,022 | 11 |
Speech (virtually) by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Data Science Conference of the Netherlands Bank Data Science Hub, Amsterdam, 13 May 2022. | Steven Maijoor: Data science for supervision - what's in it for us? Speech (virtually) by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Data Science Conference of the Netherlands Bank Data Science Hub, Amsterdam, 13 May 2022. *** I am very sorry not to be able to talk to you in person. I'm in beautiful Athens – the cradle of logical reasoning and math. Academic fields that should be close to your heart. But I have been assured that you are meeting in an equally beautiful location and are well-catered. You are very close to Amsterdam Central station; one of the busiest railway stations in the Netherlands. As data scientists you probably immediately think of all the possibilities data science offers for the railway industry. There is even such a thing as the "Internet of Trains". It's a term describing the benefits that big data brings to the railway industry, making trains more efficient, more reliable and less harmful to the environment. Its main goal is to achieve a close to 100% reliability. In other words: making sure that trains are almost never late. Similarly, banking supervisors have the goal to ensure trust in the financial sector – that is a very low probability of default. And like in the railway industry, there is a huge potential of data and data science in our area of work. As a long-time supervisor I've witnessed up close how supervision has been changing in the past fifteen years since the Global Financial Crisis (GFC). That crisis gave a big push to the collection of data to fill the 'data gaps' that existed. We now have data on nearly all parts of the financial system, including, for example, derivatives use, securities holdings and collateralised finance. In addition, a wide range of new techniques and computing power allow us to implement entirely new approaches. Taken together this allows us to do the same things better and smarter, to look into entirely new things and to do all of this this at lower cost. Let me explain these three win-wins that new data combined with knowledge of data science can offer us. Firstly, more granular data and data science enable us to do the same things better and smarter. Supervision has a long tradition of using quantitative data to assess risks. Having more granular data at our disposal allows us to assess, for example, concentration risks much better. We are now also better able to develop models to challenge those developed in the industry, which can make our supervision more efficient. I will return to an example of this in a minute: I will be discussing an outlier detection tool that we have applied with some success in Know Your Customer examinations at several banks. Also, Natural Language Processing (NLP) allows us to process written documents.With the help of NLP we can filter the most relevant information from the ever increasing flow of written information. Secondly, we can also look into entirely new things. The combination of having more granular data and new data science techniques opens up a new world. Thanks to digitalisation, data is collected and available at a higher frequency. How often do you Google something? Probably quite often. The average person conducts three to four 1/5 BIS - Central bankers' speeches searches each and every day! This obviously generates a lot of data. Techniques such as webscraping allow us to use this data, for example, to measure market sentiment and implement this is in economic forecast models to make them real-time and more accurate. Thirdly and lastly, we could potentially do all of this at lower cost. The cost of computing power and storage has gone down dramatically over time. Developing applications has become easier and, once implemented, could reduce personnel cost. Moreover, as the projects initiated by the BIS Innovation Hub show, its participants are keen to develop functionality together. This could lead to significant efficiency goals because – instead of sharing shiny PowerPoint presentations – we could share the functionality that allows us to replicate each other's analyses with our own data. Now, this conference aims to explore how new techniques can help financial authorities – that is, both supervisors and central bankers – to improve and to learn. And this is close to my heart: also during my previous role at the European Securities and Markets Authority, (ESMA), I've always been a keen supporter of increased data-driven supervision. And data-driven supervision starts with good data. And let me stress that data should be fit-for-purpose: ideally, we all want flawless information. I have seen firsthand the amount of effort and tenacity required to achieve that. However, timeliness also has value. Especially in this dynamic world in which unforeseen events like the COVID-19 pandemic and the war in Ukraine have immediate impact on the economy and the financial sector. For timely policy making, immediacy is then more important even if it might come at the cost of accuracy. There are, however, quick wins when it comes to data quality. Let me start by saying that labelling data is key, and I will give you an example. The GFC has shown us that exogenous risks – triggered by external events – are not the only risks in the financial system. Endogenous risk, generated and reinforced by financial institutions acting as part of the financial system, has shown to be as important, if not more important. That was illustrated for example with securitisations and derivatives. The increased interconnectedness and complexity within the financial system increases the importance of improved insight in the existing interlinkages and potential spill-over effects. To get a complete overview of the interlinkages, and thereby of systemic risks, one must be able to uniquely identify institutions. That is exactly why the Legal Entity Identifier – or LEI – was introduced as a global standard. However, adaption and implementation is still relatively limited, which is a pity: The more entities obtain an LEI, the greater the benefits are in terms of getting this complete overview of the financial system. Let me turn now from data to the part that is more relevant to this conference: data science. What do I expect the techniques that you are discussing to deliver? To phrase it in the simplest words: my hope is that you can replicate my WhatsApp experience. Just like many of you, I use this app a lot to communicate, and I'm impressed by – and a little bit scared of – its predictive text options. It has the uncanny ability to guess what it is I want to type next. I do not pretend to understand the underlying technical intricacies but the intuition is clear to me: by continuously correcting it, I allow the system to learn what my preferred combination of words is. The algorithm can then help me communicate more easily and more efficiently. 2/5 BIS - Central bankers' speeches What I would hope is that the methods discussed in these two days can help supervisors in a way similar to what WhatsApp has done for my communication. So, amongst other things: Algorithms should capture relevant aspects of the supervisory process and help us deliver a safer financial system. Algorithms should learn to capture anomalous payments that can be linked to illicit activities. Algorithms should help us gauge market reactions to monetary policy interventions. In all cases, the algorithms should support policy makers and supervisors to arrive at better decisions. I'm aware that this technology is not entirely free of new problems. Or, put more optimistically, challenges. For instance, the algorithm could exhibit biases and lead to discriminatory outcomes. Also, as with any data-dependent method, it is inherently backward-looking since it takes time to collect data and train the models. Furthermore, since many of the techniques are new, users often feel they are forced to use black boxes with very low explainability. Up to a point, they are right, since approaches are often a-theoretical, making it difficult to establish not just correlation but also causality. Therefore, more and more work is being done to create 'Explainable AI'. Lastly, since we often have to turn to cloud-based implementation – primarily because of computational demands – data security is an issue. I don't want to sweep these issues under the rug, but I do feel that careful application can yield benefits and that the least we can do is explore the possibilities. These possibilities have implications for how we supervise. In terms of supervision – the topic closest to my experience – these developments will have a significant impact on how we work. Let me first turn to a showcase of how we, at De Nederlandsche Bank, have applied these new techniques in actual supervision. In the last year we have employed an outlier detection algorithm in "know your customer"-deep dives at several institutions. As you all may know, a great deal of media attention is given these days to preventing financial institutions from being used by criminals for activities such as money laundering. The standards that were designed to protect these institutions against money laundering were implemented in 2012 and are also referred to as "Know Your Customer" or KYC in short. Financial institutions have to comply with the standards, and as a supervisor, De Nederlandsche Bank needs to ensure that banks have incorporated the minimum standards in their business operations and that their systems work properly in fighting financial crime. But how to detect potential fraudulent transactions in a dataset that contains millions of customers and bank accounts and billions of transactions? Data science has a clear role to play here. To identify exceptions we applied an Isolation Forest algorithm, and I probably don't need to explain it to this audience. But please indulge me while I take a few minutes to explain to you what I take away from the intuition and workings of an algorithm like this. 3/5 BIS - Central bankers' speeches Since we have limited resources and since our supervision is risk based, we are looking for the most unlikely combinations across millions of account holders with billions of transactions. To find these exceptions, we would traditionally define tell-tale identifiers. For example, "multiple accounts on a single address" and "a single deposit per month and immediate withdrawal". Seen separately these are relatively innocent. Together, however, they can indicate human trafficking of seasonal workers: the combination identifies subcontractors who organise housing for seasonal workers – which is a perfectly legal activity – but then at the same time immediately withdraw the wages deposited and only pay a fraction to the worker – which is illegal off course. However, this combination could to an extent also identify student housing: a large inflow when student grants and loans arrive and a relatively quick withdrawal rate. These are just two dimensions. In practice, there are many and these interact in non-linear and unpredictable ways. With the use of data science techniques we can identify those. Our showcase has proved itself already: my colleagues in integrity supervision can now do their work in a more efficient mannerby selecting the most risky files using data science. So what can we learn from this example?Let me draw a few conclusions: Data Science has great potential, and data scientists can definitely add value. The data scientists should however work closely with the business – that is the supervisors with the business knowledge. This is not only needed for providing input to the model, but also for interpreting model outcomes. Considering the example I just gave; while the algorithm flags fraudulent transactions that would otherwise never have been identified, left to its own devices the model is not – or not yet – able to make a distinction between illegal activities and student housing. How can you make sure that data science knowledge is always combined with business knowledge? In organisational terms this is a challenge: if you embed data science locally, how can you keep the data science knowledge up to date? Conversely, if you set up data science centrally, how do you prevent empire building? At De Nederlandsche Bank, we chose a hub-and-spoke system for this – stressing joint development. Our data scientists work in a Data Science Hub, together with the spokes – which are the various divisions of De Nederlandsche Bank. This comes with the additional benefit of making optimal use of potential spill-overs – using the same code for different applications - while at the same time working on a variety of topics, from financial markets and pension funds to payment services and even Human Resources. So far so good, but if one wants to embed the data science tools, such as the outlier detection tool, into existing workflows there is the challenge of correctly implementing and, subsequently, maintaining it. How to implement and maintain the tool? The traditional approach is to deliver a data science solution to an IT department as a Proof of Concept to implement in production. Often, this has the drawback of a longer time to market and a loss of flexibility. On top of that, there is a need to maintain the tool. Not only in a technical sense – ensuring that it remains operational – but also in a more practical sense. What if the model requires updates due to changes in the underlying data or processes? In those cases in which models are embedded into workflows, there may be a need for a stronger collaboration between the business, the developers and operations. An alternative approach with which we are experimenting is something called BizDevOps. A type of organisation I probably don't need to explain, but that encourages collaboration between these three parties: the business, the developers 4/5 BIS - Central bankers' speeches and the operations team, by combining development and operations in a single team. We are not yet sure whether this provides an optimal solution, but we believe it's worth a try. With this, I have shared some of the experiences we have gained at De Nederlandsche Bank. I am glad to see that offline conferences are back, and I invite you to make the best possible use of this and share tips and tricks during these two days. I'm especially interested to know what the speeddate session you had before lunch will bring you. We are probably all in the same phase of experimenting with data science within central banking and supervision. Let's share not only code via Github but also experiences in this offline environment.Let me also mention the Innovation Forum – or iForum – through which we want to strengthen the interaction with the financial ecosystem in the context of technological innovations. The iForum aims to move beyond just comparing notes; pilots and experiments are a core activity and maybe some of the ideas presented here can find their way to the iForum. So, let me come to a close. For me, as a supervisor it is key that the marvellous insights presented here are in the end implemented. Only when we change work processes for the better we will have a real and meaningful impact. Looking at the topics and discussions at this conference, I have no doubt that we will be successful. 5/5 BIS - Central bankers' speeches | netherlands bank | 2,022 | 11 |
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Association for Financial Markets in Europe (AFME) European Sustainable Finance Conference, Amsterdam, 11 May 2022. | Steven Maijoor: On how climate-related and environmental risks affect banking and its prudential supervision Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Association for Financial Markets in Europe (AFME) European Sustainable Finance Conference, Amsterdam, 11 May 2022. *** Hello everyone. It is a pleasure to be here today. The April 2022 report from the Intergovernmental Panel on Climate Change was unequivocal: the time for action is now. Without immediate and substantial emissions reductions across all sectors, it will no longer be possible to limit global warming to 1.5 degrees Celsius. We are at a crossroads and we need to take the right turn. Regarding climate investments, the report found that the level of investment needed to limit global warming to 1.5 degrees should be three to six times higher than is currently the case. And that fossil fuel subsidies are still too high. The current war on European soil is first and foremost a human tragedy. But it also makes painfully clear how dependent we are on fossil fuels. This adds to the urgency to reduce our dependence on fossil fuels. Many, if not all of you, are fully aware of this. So today, there is no need for me to create a sense of urgency. No, today, I want to create a sense of action. I want to talk about our governments – about what they, as the primary actors, can do for the transition to a net-zero society. And then I want to talk about you and me – the financial sector. About how climaterelated and environmental risks, the C&E risks, affect the financial system. And about how supervisors and banks can respond, or better still, must respond, to these risks. But first – our governments. The lion's share of the investment we need for the energy transition will have to be made by private parties. But our governments have an important kickstarting role to play. To accelerate and scale up climate investment, they should, first and foremost, adequately price carbon emissions. This is in line with the standard recipe for how to respond to externalities as explained in economics textbooks. Current pricing harms the business case for climate investment. We need to turn this around. To that end, carbon taxes must be raised and fossil fuel subsidies phased out. Our governments should also support and promote the financing of innovative, sustainable investment. This could be done through subsidies, co-financing and guarantees. Any such government policies should, first, be consistent and reliable so that private investors have sufficient long-term certainty. And second, they must not jeopardize the stability of public finances. 1/6 BIS - Central bankers' speeches Besides pricing and supporting, our governments have regulatory tools at hand. Through regulation, they could for example boost the private financing of innovations by promoting the market for equity finance. Equity financing is typically more conducive to innovation than debt financing. In the same regulatory toolkit are reporting requirements, such as those on climate matters, and binding supervisory and risk standards. These requirements and standards could really incentivise established businesses to reduce carbon emissions. If we want to succeed, and we need to, we need everyone to play their part. So let me turn to us now – to you and me, to the banks amongst you, and supervisors. Banks perform a crucial role in our societies. You play an important role in creating prosperity. And just like De Nederlandsche Bank wants to contribute to sustainable prosperity by safeguarding financial stability, you as bankers should also want to. I know many of you do. As central bank, our primary responsibility is financial stability. As supervisor, we look after the solidity of the financial sector. This means that we look out for risks that are a potential threat to this stability or solidity. Over the years, De Nederlandsche Bank has done extensive research on sustainability risks – mainly climate-related risks, and risks related to the loss of biodiversity. And we have found that climate-related and environmental risks can be a threat to individual financial institutions, and so to global financial stability. For instance, when you finance companies that are directly exposed to C&E risks, you, in turn, are also exposed to financial risks. Today, I want to talk to you about a few C&E risks that could have such an impact on your financial risks. When discussing C&E risks, we make a distinction between physical and transition risks. I will talk about these two first. After that, I will zoom in on three other important risks connected to climate risk: concentration risk, and reputational and litigation risks. So first, physical risk. Think for instance about the risk of a flood in the western part of the Netherlands. This could increase a bank's credit risks following from damage to collateral, like houses and buildings. And this would then require a bank to draw on its capital reserves. Second, transition risk. Transitioning to a net-zero society could lead to adjusted or new governmental policies, technological progress, or changes in market sentiment and market preferences. Governments, for example, could impose higher taxes on Green House Gas emissions. As a result, a company's revenue could decline, and with that, the company's creditworthiness and its ability to repay outstanding debts to banks. To manage physical and transition risks, they need to be identified, measured and monitored. They need to be incorporated in your risk management frameworks. 2/6 BIS - Central bankers' speeches I know many of you are aware of this. I know many of you have started thinking about how to provide finance for the transition as well as how to translate sustainability risks into your business operations. And I know that this complex transition demands a lot from you as banks. The ECB and De Nederlandsche Bank, on their part, have progressively integrated C&E risks in their supervisory methods. The ECB, for instance, introduced supervisory expectations in its Guide of November 2020. This publication urged banks to analyse those risks and integrate them into their business model, governance, risk management and disclosure. In the follow-up assessments of November 2021 and March 2022, results showed that banks have made some progress. However, significant gaps still remain, for example regarding banks' disclosures, as well as the substance of such disclosures. About three out of four banks do not disclose whether climate-related and environmental risks are material to them. This shows that these institutions either are unaware of the potential impact of these risks on their balance sheets – or are aware of their impact, but do not transparently disclose it. This year, together with the ECB climate stress tests, the Joint Supervisory Teams are conducting a thematic review on C&E risks. This means that those risks are part of the methodology for the Supervisory Review and Evaluation, and the ongoing supervisory dialogue. These conversations will most likely not be easy for banks that lag behind in terms of C&E risks. With the introduction of various European disclosure requirements, such as the Corporate Sustainability Reporting Directive and the EBA Pillar 3 ESG reporting, little time remains for banks to close the disclosure gaps. And even more standards are currently being developed, such as those from the International Sustainability Standards Board. Next to supervisory dialogues and disclosures, there is another important subject I need to talk to you about: the prudential framework. This framework is also looking at integrating climate-related and environmental risks. Last week, the European Banking Authority, EBA, published a discussion paper on whether prudential treatment of exposures to environmental risks would be justified. As far as De Nederlandsche Bank is concerned, given the global nature of C&E risks, we think that the prudential framework should ensure a minimum level of harmonisation and a level playing field across jurisdictions. To achieve this, let's look at the current framework. As a start, we should consider whether there is flexibility in the framework to respond to C&E risks. It is an undeniable fact that some elements in the framework are incapable of including information on these new risk factors. Take, for instance, the pre-set risk weights under the standard approach. 3/6 BIS - Central bankers' speeches However – some elements in the framework can quantify and incorporate C&E risks whenever they materialize. Take, for instance, the internal model parameters like Probability of Default or Loss Given Default. And some elements in the framework are already able to incorporate new information regarding climate-related risks. For example, before C&E risks materialize, External Credit Rating Agencies could take into account available and relevant information regarding environmental factors. They could use this information for the determination of external credit ratings that banks may use for their standard models. As current practices across Credit Rating Agencies differ, steps should be taken to improve consistency, comparability and reliability of the data underlying credit ratings as well as to improve the transparency of the rating methods. But, even after explaining and refining the current framework, this would still not fully strengthen banks' resilience against C&E risks. We see an increase in frequency and materiality of climate-related and environmental risks. And as a result, banks' exposures may be affected simultaneously through multiple channels. That is why De Nederlandsche Bank is in favour of addressing concentration risk originating from C&E risks. This risk follows from shocks arising from concentrated exposures to physical or transition risk drivers. What's new about this perspective on concentration risk is that seemingly unrelated counterparties may be subject to shocks arising from similar risks – physical risks due to location, or transition risks due to sectoral exposure. To properly address concentration risks, the framework should be fundamentally changed. But introducing a new instrument would be even better. Currently, discussions on how to translate the theoretical insights on concentration risks into a practical instrument are on-going. One option that is being looked into is a quantitative concentration limit, either absolute or relative. This limit would then be subject to supervisory reporting, disclosure or an additional capital buffer. And in case of a breach of the limit, a range of supervisory measures could be considered, such as a mandatory notification in accordance with the Large Exposures framework or a deduction of the excess part of the concentrated position from the bank's capital. If this concentration limit were to become part of the prudential framework, it could well be phased in to give you, banks, time to make the necessary adjustments. I do want to stress, though, that our ideas on concentration limits are very much in the proposal phase. De Nederlandsche Bank is looking forward to comments on this proposal and to the results of any consultation rounds on the EBA discussion paper. These could in turn help us to improve the proposal. So far, I have discussed climate and environmental changes as a source of prudential risks. However, some banks also consider these changes, and the related changing stakeholder preferences, as an opportunity to change their strategy and business model. For example, I find it promising to see that a number of banks are committing, 4/6 BIS - Central bankers' speeches themselves, to net-zero initiatives. Such as the banks that choose to align with the Paris Agreement by signing the Commitment Statement of the Net-Zero Banking Alliance. Institutions that have signed this statement have 18 months to do a number of things. They need to identify operational and attributable Green House Gas emissions from their lending and investment portfolios. And then they need to set specific targets, for both 2030 and 2050, so that they can align with the trajectories towards net-zero in 2050 or earlier. To achieve these targets, banks might need to adjust their business model and their range of products and services. Or they may need to adjust their decision-making process and thus adapt their governance structure and risk management procedures. It is important that banks provide qualitative and quantitative disclosures to support their commitments. As mentioned earlier, the recent ECB assessment shows that banks do not fully meet ECB expectations on disclosure of C&E risks. And this is where the final risks I want to mention today, occur. Reputational and litigation risks. These risks follow from an increased stakeholder awareness for a netzero society. For instance, if stakeholders feel that a bank is not living up to its commitment, its reputation could be harmed. Activist measures or changes in consumption patterns could follow. The goal being, ultimately, to drive banks towards a more environmentally friendly business model. Banks may also be exposed to an increasing litigation risk. If a bank, as a signatory to a climate commitment, does not live up to it, not only could its reputation be harmed, it could even be held liable, for example by NGOs. And so not living up to a climate commitment, for instance by not providing sufficient qualitative or quantitative disclosures, may lead to reputational and litigation risks that could have financial consequences. I'm wrapping up. Today, in talking to you about the risks of global warming, I am not crying wolf. I, and many with me, know that the threat is real. That we need to act. That we need to make significant progress in the pathway to net-zero. As a sort of shepherd of financial stability, I want to do what I can to protect our society against the wolf that is global warming. I want to do what I can within my mandate as supervisor. But global warming knows no borders. Not between sectors. Not between countries. Global warming affects all of us. Everyone. Everywhere. And so, we will only succeed if everyone, everywhere, does their part – governments, banks, and supervisors. If everyone, everywhere, within their respective mandates or from within their business operations, contributes to achieving our common goals – protecting lives and livelihoods. 5/6 BIS - Central bankers' speeches So with that, comes a different cry. With that, comes a rallying cry. A cry to move from a sense of urgency to a sense of action in the fight against global warming. I hope you are with me. Thank you. 6/6 BIS - Central bankers' speeches | netherlands bank | 2,022 | 11 |
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the FSG (the Financial Study Association of Groningen) Conference, Amsterdam, 8 March 2022. | Steven Maijoor: Banking in the digital age - seizing opportunities, managing risks Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the FSG (the Financial Study Association of Groningen) Conference, Amsterdam, 8 March 2022. *** I am not here today to discuss world politics, of course. But I do want to stress that the financial system is not an island. It is very much interlinked with other domains in our economies and societies. I think it's good to keep this in mind when discussing the challenges financial markets face today. Before diving into a few of these challenges, allow me to properly introduce the organization I work for: De Nederlandsche Bank. Or DNB, in short. Almost everyone knows we exist, almost everyone knows our name, but not everyone knows what we actually do. Of course, you as finance and economics students probably know a lot more about us than the average Dutch citizen. But still: what is it then what we do at De Nederlandsche Bank? First of all, we aim to keep inflation low and prices stable. This simply means you can buy as much with your money tomorrow as you can today. As you may have noticed – recent and less recent events have made this a challenging task. Next, we supervise banks, insurance companies, pension funds and other financial institutions. We do this so they can weather a rainy day and can perform their essential role in our economy, and your money is safe. We also ensure that payment systems are running efficiently and safely. Whether you are shopping or just paying your coffee, it is important that the network behind it helps the money flowing smoothly and efficiently. And then there is still something called banknotes. The younger you are, the less probable you use them, but at De Nederlandsche Bank we also still develop and issue banknotes. And we use the newest technologies to make these banknotes more secure and resistant to wear and tear. And then finally, we do research and we advise the government. We do this on all kinds of topics – ranging from the government's budget and the housing market, to the labour market and crypto assets. Of course, we don't do everything we do just on our own. Contrary to what our name suggests, De Nederlandsche Bank has gradually, but essentially, become a European organization. We are part of the European System of Central Banks. This is where the ECB meets with the central banks of the other 18 countries that use the euro – and where jointly decisions are made. 1/5 BIS - Central bankers' speeches Also together with the ECB, and with supervisors from the other countries of the eurozone, we supervise the banks. Take, for example, the teams that supervise the largest Dutch banks, such as ABN AMRO, ING or Rabobank. These are very international teams. So if you would visit our temporary offices next to the Amstel Station in Amsterdam, where we await our return to the Frederiksplein, you will just as easily hear Dutch as English, and even French or Italian or other European languages. But that's only Amsterdam. If you come to work for us, it is very likely that before long you will head to Frankfurt, where the ECB has its offices. Or to any other European financial capital – to work, for example, on how to regulate bitcoin, or on how to keep payment systems safe from cybercrime. Or you could even be stationed at a major European bank for several months as member of an onsite supervisory team. For an organization that was founded more than 200 years ago, that's pretty dynamic. And we have to be. Because the financial sector is dynamic. Take, for example, the area where I am mainly responsible for: banking supervision. These are exciting times for banking. And this has everything to do with digitalization. Let's take for example all the new players in the market. Even as short as 5 years ago, we all paid with our bank-issued debit or credit cards. Companies who wanted to take out a loan went to their bank or intermediary. Now, we pay with our smart phones using Apple Pay and Google Pay, or on web shops using innovative payment service providers. And companies who sell their goods on market places like Bol.com or Amazon can obtain credit through those platforms. Moreover, banks are increasingly moving their ICT processes into the cloud, cooperating with large BigTech cloud providers like Amazon, Microsoft or Google Cloud. So new players are coming into the financial sector and becoming increasingly important. These players are often tech players, be they BigTechs or FinTechs. We are also seeing a change in business models. We see a move toward platforms that are a sort of one-stop-shop for consumers, providing them with all kinds of services, financial but also non-financial. Here we can think of BigTech platforms: as I said, Amazon allows vendors to obtain credit via its platform. Consumers can also get an Amazon credit card and buy insurance on Amazon products on the platform. Google, until recently, was planning to offer a portal, called Google Plex, in which its customers could manage their bank accounts. And traditional financial institutions, on their side, are looking to set up platforms of their own. They still offer financial services, of course, but also focus more and more on nonfinancial services. What drives all of this is, of course, technology. New technologies. Like data and Artificial Intelligence. These were initially not developed specifically for the financial sector, but as I said earlier, the financial sector is not an island. So these technologies have increasingly become important for banks and insurance companies. We all know FitBits or AppleWatches that track our health data. These data can then be used in 2/5 BIS - Central bankers' speeches insurance, but also for banking services. And it's not just health data, of course. Many different types of data are increasingly used and useful. Think of data on energy consumption, or payments data. All these can help inform credit risks on loans. So with new analytical tools, like artificial intelligence and machine learning, banks can increasingly use more and new types of data. Let me also say a few words on crypto assets and the use of blockchain. There has been a lot of talk about these in the financial sector. And indeed, this is likely to be one of the most important developments in payments, but also in banking more broadly. Blockchain technology, which enables something called decentralized finance, even puts into question the very need for traditional payment systems and key functions of banks, at least in theory. To understand this, let's take a small detour and do a 1 minute crash course, or at least fresh-up, on banking. What is a bank? Of course there is a building, there are bank employees, there are ATM'sc, etc. But in theory, you could all do without these, and in fact banking is less and less about bricks and banknotes. What is left then, is essentially a balance sheet. That is where saving deposits are held and loans are provided. That is where a bank creates money. That is what you need to provide basic banking services. Right? Well – enter blockchain. I will not go into the technical details, but this technology essentially makes it possible to do financial transactions as a chain of entries in a bookkeeping system that is accessible for everyone. The only thing you need to keep this running is a lot of computers. In such a system, decision-making, risk-taking and record keeping would all be decentralized. No balance sheets, no central records, no banks – at least in a traditional sense. It is clear that we are far from widespread adoption of fully decentralized technologies in financial services. But still, the combination of new technologies, new players and new business models raises mind-boggling questions about the future of finance and what that means for policymakers and supervisors. And that's the next issue I want to talk about. How can my colleagues and I, at De Nederlandsche Bank and elsewhere, ensure, also in the digital age, that the financial system remains robust, and you as consumers stay safe? Whom should we supervise? Do the existing policies and rules still apply? Or should new rules be set? These are fundamental questions that we are dealing with at the moment. In the coming years, DNB will become more and more acquainted, in its supervision, with new technologies and new tech players. For instance, in the next few years, we and other financial supervisors will start overseeing large cloud providers that provide critical ICT services to banks. We will also play an important role in supervising new technologies used by banks, such as Artificial Intelligence. Crypto-asset, like bitcoin and many other, are a case in point. We and other central banks have been monitoring crypto-asset developments closely over the past years. The most recent risk assessment shows that markets for crypto-assets are fast-evolving and could reach a point where they represent a threat to the stability of the global financial system. 3/5 BIS - Central bankers' speeches Probably a lot of you hold some form of crypto-assets. Of course, it can be instructive to try things out on a small scale and get to understand the technology behind it. But I must say I have my concerns about crypto-assets. Let's take for example all the misnomers that are doing the rounds. Unbacked crypto-assets suggest all others are backed, which they are not. Most stablecoins are neither stable nor coins. Decentralized finance is often quite centralized. These misconceptions contribute to the fast growth of crypto-assets. And this is without even going into cybersecurity and money laundering issues. So at the moment, we are investigating with central banks worldwide what is needed to keep the risks from crypto-assets in check, and what that means for regulation. The global Financial Stability Board, which is chaired by the president of DNB, Klaas Knot, is overseeing these activities. And at European level, regulatory action is already well underway. The EU has almost reached agreement on legislation aiming to ensure that crypto assets and stable coins are properly regulated and supervised. As DNB we very much support the regulation of crypto-markets, because there are risks involved in crypto's that need to be kept in check. And because of the cross-border nature of crypto's it is important that these new rules apply across the EU. So that we can protect consumers but also help market players to do business across the EU without barriers. And within the Eurosystem we are conducting a project to assess the need for a digital euro, an electronic alternative for the euro banknote. This digital euro could possibly serve as a safe and stable alternative to crypto-assets. Together with a few other central banks, DNB forms a pilot group that is actively investigating and experimenting with this. So – a lot is going on. And a lot of this touches the very foundations of our financial system. So I can assure you – these are very exciting times to work for a central bank and banking supervisor. At least two completely new dimensions are added to our supervisory work. First of all, we ourselves are increasingly using new technologies to improve our supervision. This includes the digitalization of our supervisory processes and using Artificial Intelligence. And secondly, we are increasingly working with a whole new group of supervisory partners. I already mentioned the international dimension of our work. But with the changing banking landscape, we are also reaching out to data protection and privacy authorities, to criminal prosecution authorities, and to public authorities responsible for internet governance. It is time to wrap up. The banking landscape is changing fast, and the stakes for organizations like us, De Nederlandsche Bank, are high. As central banks and supervisors, we have a responsibility to make sure that we can continue to keep the financial system stable and safe. We want no holes in the global financial safety net, however much it gets stretched and reshaped. To do this, we need the best and the brightest from all kinds of disciplines. We need people that see the bigger picture. 4/5 BIS - Central bankers' speeches And with this not so subtle hint, I am closing my remarks, and I am happy to answer any questions you may have. 5/5 BIS - Central bankers' speeches | netherlands bank | 2,022 | 11 |
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the 6th Annual Afore Conference, Amsterdam, 9 February 2022. | Steven Maijoor: Changing landscape, changing supervision preserving financial stability in times of tech revolution Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the 6th Annual Afore Conference, Amsterdam, 9 February 2022. *** Hello everyone. It is great to be here again at the Afore Conference 2025. Yes, you heard me correctly. It is 2025, and it's already the third physical conference since the end of the COVID pandemic a few years ago. You may have come here by car. As you drove on the highway, your semi-autonomous vehicle was sending realtime data on your driving style to Google Insurance. Your insurance premium is adjusted accordingly every month, and the underwriting risk is sold to a white-label insurance company. Since you've had this car for almost three years now, you're soon expecting the first ads on your smartphone for the car models that your eyes have been scanning over the past few months. They will be accompanied by several personalised financing offers from banks and fintechs, based on your credit score data collected from a host of e-commerce and other data sources. Since the exchange rate has been rather favourable lately, it may be attractive to use the stable-coin savings you hold in your ewallet attached to your favourite BigTech platform to make the purchase. Sounds like science-fiction? I wouldn't be so sure. Some parts of this scenario are already becoming reality as we speak. And although it is notoriously difficult to make predictions about the future, technological developments are going so fast that it may be wise not to dismiss this, or any other, scenario upfront. Now personally my tech-savviness has its limits. My son is friendly enough to remind me when I play FIFA with him on the Play Station. But believe me, I'm just as excited as you are about the tech revolution. Also as a financial supervisor. Because let's face it, fintech may offer large benefits to consumers in terms of new services, ease of use, inclusiveness, and costs. Over the years, as a conduct supervisor at ESMA, and now as a prudential supervisor at the Dutch central bank, I've seen quite a lot of innovations. I see innovation as a good thing. Throughout history, financial innovation has often been a driver of economic growth and prosperity. That's why in a market economy, the challenge for financial supervisors has always been to adapt to innovation. So that we can benefit from the good, while keeping in check the bad. Nothing new, you might say. But still, amid all the excitement, I understand the nervousness of financial supervisors about fintech. Because right behind the high-tech picture I just painted for you, all kinds of new risks and uncertainties are looming, many of which go to the very heart of our mandate, which is to safeguard the stability of the financial system. For example: Will the well-known market power of BigTechs increase concentration risks in finance? As the value chain gets sliced between various parties, is it still clear who bears the ultimate financial risk? And how can we be certain it's still managed and priced adequately? What if a major incident relating to data privacy triggers a loss of trust in a 1/4 BIS - Central bankers' speeches BigTech? These are just a few questions. There are many more. Some have no doubt already been mentioned by previous speakers. But perhaps the most fundamental question is this: in a system where so many new, previously non-financial, players are becoming instrumental in offering financial services, how are we, as financial supervisors, going to ensure that the financial system remains robust and consumers stay safe? How can we make sure that we continue to have the right mandate and effective instruments to ensure that outcome? Let's take for example the rise of platforms. Banking and insurance are increasingly offered as a service on a platform that offers all kinds of other products and services. Platforms are often active across various sectors, and here financial regulators are not the only, nor even the primary regulator as they used to be. This makes it more complicated for them to have the full picture of the activities and risks of the entire platform. It also raises questions about the extent to which financial regulators should look at a platform's non-financial activities. Next to the issue of having the full risk picture, financial supervisors will have to act more and more on the basis of what I call horizontal rules and regulations. Rules that are not specifically designed for the financial sector, but have a much broader application. Like for example on data privacy and Artificial Intelligence. But financial policymakers and regulators do not have a seat at the table where and when these rules are set. Blockchain-based platforms pose even more profound challenges. These are often a great deal more decentralized than traditional financial intermediaries. What is the supervised entity here? Next to the rise of platforms, another important development is stablecoins. The use of private stablecoins is still limited, partly because of their risks to users. But stablecoins also have features that could make them attractive, for example in countries with weaker institutions and unstable national currencies, and for cross-border payments. As soon as the conditions are right, things could go very fast. Based on the experience with dollarization in developing countries, we know there is a tipping point beyond which adoption of a new currency increases exponentially. Without regulation, such a steep rise in the use of private stablecoins could pose a threat to financial stability. Given the nature of this new wave of innovation, the guardians of the financial system will have to be innovative themselves in redesigning regulation and reorganizing supervision. I think cooperation is key here. Since the tech revolution crosses both geographical and sectoral borders, regulators and supervisors from various jurisdictions, remits and sectors will have to join forces. Now, again you might say this is not new. Regulation and supervision have always followed the changing structure of finance. In the 1980s, regulators responded to the internationalisation of banking by forging an international agreement on minimum 2/4 BIS - Central bankers' speeches capital requirements: the Basel Accords. And in the 1990s, the rise of financial conglomerates was followed by regulations on consolidated solvency and the crosssectoral merging of financial supervisors. But at the same time, these examples immediately make clear what the scale of the current challenge is. Because this time change does not take place across one, but across multiple dimensions: national versus international, financial versus non-financial, entities versus activities. And that all at the same time. This is not Basel 3, this is Basel to the power of 3. So whatever we do, we'd better start by ordering a couple of very big meeting tables. Or, in the spirit of this conference, tick the large gallery view. So how to proceed? Let's look at regulation first. As we have seen, both platforms and new technologies do not operate exclusively in the financial sector, but do play an increasingly important role there. I think we should therefore recognize that horizontal regulation is often the best way to regulate them. For instance, the European Services Act and Digital Markets Act are important tools for regulating platforms. Similarly, the expanding automated access to data cannot just be addressed within the confines of the financial sector. Increasingly, non-financial data, like for instance the data your car produced on your way to this conference, are key to innovation in the financial sector. Developing a framework for data access must therefore be done at the horizontal level. But that means that financial policymakers do have to have a seat at the table when these regulations are being developed. This requires a shift in the thinking of both financial and non-financial regulators. More horizontal cooperation needs to be mirrored by more international cooperation. For example, the rise of platforms comes with the risk of regulatory arbitrage, far more so than was the case in traditional finance. International consistency is needed in how platforms are regulated, for instance in the regulatory approaches to BigTechs. Another key example is stablecoins, where we have seen different jurisdictions moving towards regulation, and where consistency is especially needed. This will only become more important as decentralized finance grows. And given the pace of developments, it might be wise to build flexibility into the regulatory framework. This could be done by adopting a more principle-based regime at the level of the primary legislation while delegating more to the European Supervisory Authorities (ESAs). I know very well that there are legal considerations making it difficult to achieve this. But we should push the boundaries here to ensure that the regulations of fintech are as effective as possible. At global level, the FSB has a key role in ensuring an overall consistent approach, and for bringing all the necessary expertise together. Next to regulation, the sector's changing structure also calls for us to rethink supervision. First, I believe we should look more towards the EU-level, and where necessary move financial supervisory tasks related to fintech to the ESAs. A good 3/4 BIS - Central bankers' speeches example of this is MiCAR. Moreover, the remit of financial supervisors may have to be expanded so they can continue overseeing key parties in the financial value chain. The DORA Regulation makes this possible by introducing financial oversight of non-financial Critical Third-Party Providers. To make that oversight as powerful and efficient as possible, I do believe it should be properly resourced and as much as possible centralized with one of the ESAs. In addition, as the lines between financial and other sectors blur, we need cooperation arrangements with other types of supervisors. These can take different shapes depending on the issues at hand. In the Netherlands, for example, supervision of payment service providers under the PSD2 Directive is conducted by the two financial supervisors jointly with the data protection and competition authorities. In the future, we may even have to move towards joint, centralized supervision in newly formed entities. And by centralized I mean not only across financial subsectors, but also across the financial and non-financial sectors. That may be the case for supervision of cloud providers. In order to prevent fragmentation and duplication in cloud supervision, we should consider a new European horizontal cloud supervisor that would have a mandate regarding the resilience of cloud providers and their compliance with privacy rules. The board of this horizontal cloud supervisor could consist of representatives of the ESAs, the European Data Protection Board ENISA, and possibly other relevant supervisors. This, of course, will not happen overnight. Over the next few years we have to work to make cloud supervision under DORA as effective as possible. But I think the centralization option is something to keep in mind when we will review the DORA framework in a few years time. As the financial sector transforms, the stakes – and gains – from cooperation are high. As financial regulators and supervisors, we have a responsibility to make sure that we can continue to deliver on our mandate to safeguard financial stability. We want no holes in the global financial safety net, however much it gets stretched and reshaped. So let's live up to that responsibility and take the first steps now. So that people can drive to the Afore Conference or elsewhere three years from now, knowing that their money, in whatever shape, is safe. And that as finance proceeds further into the digital age, we continue to have a stable and efficient financial system that works for all. 4/4 BIS - Central bankers' speeches | netherlands bank | 2,022 | 11 |
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Cumberland Lodge Financial Services Summit, Windsor, 4 November 2021. | Steven Maijoor: Strong like a castle? Challenges for banking in a post-Covid world Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Cumberland Lodge Financial Services Summit, Windsor, 4 November 2021. *** I must say: it's very brave of you to invite me to entertain you during dinner. As a Dutchman and supervisor, I will need to avoid the impression of speaking from a pulpit, but rather give a speech in the same spirit as today's open discussions. The beautiful place we are today, with Windsor Castle only a few miles down the road, inspired me to do a little thought experiment about castles. The British isles are full of them, one even more majestic and impressive than the next. But as you know, castles are not a British invention. They were imported from France. The success of the Norman conquest was not only due to William beating Harold in the battle of Hastings in 1066. It was also because as soon as the Normans landed, they put up castles all over the place. And once these stone fortifications were erected, they were impossible to tear down. It was a formidable military innovation that changed the course of history. Castles remained a crucial instrument of warfare for ages. Until the introduction of gunpowder changed their role forever. With some imagination, you can see a fair few similarities between banks and castles. Invented in the 15th century, banks were a major financial innovation that changed the course of economic history. They have performed a crucial role in our economies for centuries. And they too had to adapt in the face of change and disruption. Indeed, life for banks in Europe hasn't been easy lately, on both sides of the Channel. Their business models and profitability are under pressure. As a central banker and financial supervisor, I care about this, because banks' profitability is an important driver of their capital strength and financial stability. In the short term, the economic exit out of the Covid pandemic poses a real challenge to the asset quality of banks. I have always been intrigued by the term 'non-performing loan'. It has a subtle British understatement to it. This is especially refreshing to someone like me coming from a Calvinist country where the word for debt – schuld – is the same as the word for guilt. But still, we are talking about a situation where someone may not pay back your loan. For a bank, that's potentially life-threatening, because it can erode your capital. Since the beginning of the Covid crisis, European banks haven't pulled up their drawbridges, but instead continued lending to firms and households. At the same time, they increased provisions, in expectation of a surge in non-performing loans. But so far, the impact of Covid on asset quality was not as bad as expected. So now, banks have started to release provisions again, reflecting the brightening outlook for the economy. 1/4 BIS - Central bankers' speeches But isn't that a bit too soon? True, the economic recovery in Europe looks strong. But let's not forget the unprecedented nature of what happened. One of the reasons why we haven't seen lots of firms go belly-up during the pandemic, is the unprecedented scale of government support. Support that has kept many firms afloat that might otherwise have gone bankrupt. Competition, and the process of creative destruction that goes with it, has been suppressed for the past 1.5 years. To give you an idea, at the height of the pandemic, bankruptcies in the EU had fallen by half compared to pre-pandemic levels. In spring this year they were still only at three-quarters of these levels. And in the meantime some very significant changes to economic activity and customer preferences have taken place that are likely to be structural. Think of the rise of the online economy, think of the shift away from inner cities to the suburbs or rural areas. We simply haven't been here before. With the wind-down of government support measures, the true picture of the health of firms will gradually emerge. How many firms might still go under? We simply don't know. But bankruptcies are creeping up again. So banks should be careful and not release provisioning too soon. The Covid-legacy also means banks need to take a close look at another part of their defences: risk management. The pandemic presents unique challenges for managing credit risk. Assessment of bank practices by supervisors, at least in the eurozone, shows that not all the banks have sufficiently strong credit risk practices in place. Too many banks have insufficient high quality data and early warning systems. They are continuing to drag their feet when it comes to classifying problem loans, and are applying inadequate practices for provisioning, valuing collateral and making financial forecasts. So a broader adoption of good credit risk management practices is needed. All in all, my message to the banks is this: be careful, don't release your provisions too soon, and strengthen your guards. The business model of a castle was for the lord to tax the peasants in his estate, in exchange for protection. But if harvests were bad, that reduced the lord's ability to levy taxes. His income fell, and he had to look for other sources to cover costs. That basically describes the challenge low interest rates pose to bank profitability. For some time the impact on banks of falling interest rates seems to have been ambiguous. On the one hand banks' interest margins have been compressed. On the other hand, lower rates may simultaneously have had a positive effect by supporting banks' lending volumes and trading book valuations. But evidence shows that since 2020, the already slim bank interest margins have been squeezed further. Lending growth has not been able to compensate that, and this resulted in a drop in net interest income. For European banks, the decline was 5% yearon-year in 2020. 2/4 BIS - Central bankers' speeches Banks will likely have to operate in a low interest rate environment for some time to come. One important way for banks to tackle the challenge of lower interest rate margins is to enhance cost efficiency and to refocus their business models towards noninterest income. Encouragingly, several banks have recently taken the route of doing just that. We have seen banks strengthen their position in the fee and commission income-generating business. For instance, by acquiring asset management, custody or securities services business lines, or by merging their businesses with competitors. By doing so, banks further diversify their business and increase the scale of their operations, which is a very important condition for success in these areas. Think of what the lord of a castle would do if his tax income dropped. He would start raising tolls on passing ships, look to conquer other lands, perhaps compete for the hand of the king's daughter. So my message here is: don't wait for interest rates to return to higher levels but look for other ways to create value. The biggest challenge castles had to face was the invention of gun powder. The arrival of gunpowder shifted the function of castles. Their role evolved from a purely defensive one to a more residential one. Other defensive structures came up, like forts. They were more suitable for firing off canons themselves, thus adopting the new technology. So too the arrival of new technology and new players will change the role of banks. Our gunpowder challenge is FinTech, and especially BigTech. The influence of BigTech firms in banking is growing rapidly. I am sure at least some of you are already using Apple Pay or Google Pay. Banks are increasingly outsourcing to the Cloud. And banks and BigTechs are joining forces in SME lending. For example, a bank starting to offer loans to merchants active on a web-based platform, using transaction information from that platform. The entry of BigTechs makes banking an industry ripe for disruption. I think we should not fear this new challenge. I am not one of those who believes BigTech will tear down the banks. But I am convinced that BigTech will change the rules of the game. How exactly will partly be determined by the strategy of BigTechs. Will they choose cooperation or disruption? But it will also depend on the innovative power of financial institutions: on their vision and strategy, their capacity for change, their ability to attract talent. Financial institutions have already innovated successfully in some cases, and they have to continue doing so in the future. So my message to banks is: innovate. If you succeed, you will be able to shape innovation in financial services. If you fail, you may find yourselves in a dependent position. The rise of BigTechs in the financial sector also has implications for regulators. First of all, we will have to seriously challenge banks on the sustainability of their business model. And what does the rise of BigTechs in the financial sector mean for 3/4 BIS - Central bankers' speeches concentration risk and systemic risk? We have worked for years to solve the problem that many banks are too-big-to-fail, and now BigTechs are entering the scene, raising similar issues. The recent outage of WhatsApp offers a stark reminder of what could happen if crucial technological infrastructure fails. Existing regulation may need to be adjusted to address these risks. Supervisors at European level and beyond will have to team up to prevent gaps, conflicts and overlap in regulation. Not only across borders, but also across areas of competence and expertise, such as cybersecurity, data protection, competition and financial supervision. One of the great things about the Norman conquest of 1066 is that after that Britain was never invaded again. Some see Brexit in that historical context. As is clear from the topics of the panel discussions earlier today, the future relationship between the EU and the UK is still subject to lively debate. But what is clear is that cooperation is more important than ever. Many challenges the banking industry faces today are relevant on both sides of the Channel. In order to overcome them, we need to work together. To stay strong and dependable. Like Windsor Castle-. 4/4 BIS - Central bankers' speeches | netherlands bank | 2,022 | 11 |
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Institutional Digital Assets and Crypto Regulation Symposium, London, 17 November 2022. | Steven Maijoor: Public trust - the litmus test of financial innovation Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Institutional Digital Assets and Crypto Regulation Symposium, London, 17 November 2022. *** Hello everyone. It is great to be back in London – one of the great financial centres in today's globalised world. Before I delve into the developments of the day, I'd like to draw some parallels between crypto-asset markets and a key historic financial innovation. I'll argue that the lessons we learned in the past remain relevant for our regulatory efforts today. I'll also argue that successful financial innovations must be underpinned by public trust if they are to stand the test of time. To illustrate, let's go back to 17th and 18th century Amsterdam, which became a staging ground for significant financial innovation. After a long and arduous struggle, the Netherlands was able to gain independence from the Spanish empire. This kickstarted a period of rapid economic growth. One of the developments that proved instrumental to the Dutch economic and financial success was the emergence of a stablecoin avant la lettre. My colleagues from the Bank for International Settlements (BIS) and the Dutch Central Bank (DNB) have written a very thoughtful piece on the Bank of Amsterdam and its proto-stablecoin, the Guilder, but allow me to summarize.1 Four centuries ago, many different metal coins circulated in the Netherlands. And exchanging one coin for the other happened in the streets. You can imagine how cumbersome trading was. But then, in 1609, the Bank of Amsterdam was founded. And its services were simple. The Bank of Amsterdam allowed merchants to deposit their metal coins – any coins that were in circulation – into a deposit account. It would then value these coins against each other and credit merchants with Bank Guilders. And this would allow for easy transactions between deposit accounts. This is a great example of human innovation. Just as the entire financial system is indeed proof of our immense human creativity. The reason that today, after so many centuries, we still have a well-functioning financial system – a system that, I dare say, has generally improved over the course of many years – is because, sooner or later, the litmus test for any financial innovation is the public's trust. That trust is the true bedrock of our financial system. That trust allows for innovations to be incorporated in the financial system, and to be further advanced. Or for innovations to be found flawed and to be cast aside. 1/5 BIS - Central bankers' speeches And it is to a lack of trust that the Bank of Amsterdam ultimately fell victim. That happened once the Bank of Amsterdam started doing more than its charter allowed. Under political pressure, it moved away from full reserve backing to issuing loans. Eventually, it was the combination of flawed governance and a lack of transparency that led to the downfall of the Bank of Amsterdam. They allowed the Bank of Amsterdam's management to operate in violation of its founding principles. Despite this opacity, it did not take the general public long to figure out the Bank's safes were emptying out rapidly. A revelation that led to several severe runs on the bank. The institution never really recovered from this break-down of public trust and was ultimately dismantled in 1820. Since then, the public's trust in the financial system has been reinforced by rules and regulations – and, of course, the enforcement of those rules and regulations. Whether they deal with governance, transparency or other aspects of trustworthiness. Flash forward to today. And today's headlines. Crypto-assets, or to be more exact the underlying distributed ledger technologies, are innovations with the theoretical promise of real societal benefits. But, when there is no way to know who is to be trusted in the crypto eco-system, the potential benefits will certainly not outweigh the risks. What I often hear, is "this time is different".2 "This time, there is no need for rules and regulation." "This time, there is no need for supervision." Well, just in the past few days alone, we've been able to see that these times may not be so different at all. And that is no surprise. Because the crypto eco-system is not nearly as different from traditional finance as is often proclaimed. Many activities in the crypto-ecosystem strongly resemble activities in traditional finance. Think for instance about lending, deposit-taking, trading, or insurance, amongst others. And in resembling traditional finance, crypto-assets also borrow risks from traditional finance. These include leverage, liquidity mismatches, or interconnectedness. And going beyond theory: however attractive removing central intermediaries might sound, in practice, distributed ledger technology will come with other costs and frictions – such as significant energy consumption3 or a limited transaction throughput when settling a large number of transactions.4 So, yes – the technology underlying crypto-assets is different from the technology used in traditional finance. And yes – this technology holds the promise of potential improvements. But, the economics underlying the crypto eco-system are actually not so 2/5 BIS - Central bankers' speeches different from traditional finance. So no - "it won't be so different this time". As always, too little supervision and regulation will attract malicious actors, purporting to offer reliable services. At present many crypto markets are characterised by pseudonymity and high levels of information asymmetry. Which means that it is often impossible to know ex ante which actors have bad intentions. Or indeed, which platforms are at risk of the type of overreach that the Bank of Amsterdam was tempted into. Recent crypto-market developments have highlighted once more the age-old lesson that trust is built in drops and lost in buckets. As always, the financial innovation of the day will undergo the same public scrutiny as the Bank of Amsterdam faced three centuries ago. Whether with regards to reserve backing, governance, transparency or other issues. And after carefully scrutinizing the current crypto eco-system, the Financial Stability Board (FSB) sees legitimate reasons for concern.5 As one of the guardians of financial stability, we believe the rapid growth of these markets in the presence of structural vulnerabilities and incomplete regulation and supervision, mean crypto-asset markets could soon reach a point where they represent a threat to the stability of the global financial system. Especially given the large and continued institutional interest from traditional financial parties. I think the mere fact that we – crypto-native companies, regulators and traditional institutions – are all together here today, shows crypto cannot simply be considered a fad. The FSB's concerns are underscored by the fact that many crypto activities are not in compliance with existing regulation or take place outside of the regulatory perimeter; that existing crypto-asset regulation differs across jurisdictions; and that monitoring of financial stability risks is challenging given limited regulatory reporting and public disclosure. So, enhanced regulatory action is definitely required. Let me touch upon three elements that are important for the way forward. First, the FSB is well-aware that the cross-border nature of crypto-assets poses an obvious challenge for national supervisors. Inherently cross-border activities, like those conducted in the crypto-ecosystem, require a regulatory response that is coordinated across borders. And this is exactly what the FSB has been working on. Regulators and supervisors will not only need to work together across borders, but also across sectors. All kinds of activities can be found in crypto-asset markets: lending, deposit-taking, and insurance, to name a few. At the same time, financial supervision is often organized across different sectoral authorities with different mandates. Meanwhile, cross-border collaboration is still too often organized along sectoral lines. In our recommendations, we urge authorities to look beyond these sectoral boundaries. In its own work, the FSB aims to overcome sectoral lines by coordinating its crypto policy work with the different sectoral standard-setters, both within and outside its membership. Second, crypto activities in many ways resemble the activities of traditional finance. That is why we think crypto activities should be regulated on the basis of the 'same 3/5 BIS - Central bankers' speeches activity, same risk' principle. This would ensure that financial activities, no matter how they are delivered to end-users, are treated in a technology-neutral manner. To advance this, the FSB has published two consultative reports with recommendations: One report that reviews the FSB's high-level recommendations of October 2020 for the regulation, supervision, and oversight of "global stablecoin" arrangements, and which has proposed revisions to strengthen the recommendations in light of recent developments.6 And another report which has focussed on broader crypto-asset activities and markets and proposes recommendations that seek to promote the consistency and comprehensiveness of regulatory, supervisory and oversight approaches to crypto-asset activities and markets.7 It also proposes strengthening international cooperation, coordination and information-sharing. The principles that we have proposed are high-level – which means that they can be flexibly applied by national authorities and can be adapted as the market further evolves. Third, while the FSB work has focused on the financial stability implications of cryptoasset markets, there are of course also other policy goals that warrant attention from regulators. Currently, we see wide-spread fraud and malicious behaviour in the cryptoecosystem. So market integrity, consumer and investor protection, as well as AML/CFT, should also be on regulators' agendas. And not only on theirs, also on the agenda of crypto-service providers. Indeed, the industry needs an increased 'risk consciousness' and to build up its resources to monitor and mitigate all kinds of financial risk. The FSB's proposals, along with the work undertaken by the standard-setting bodies (SSBs), should provide a foundation for greater consistency and cooperation among authorities in the regulation and supervision of crypto-asset activities and markets. Until 15 December 2022, the FSB is soliciting comments on its published recommendations. And I encourage you to participate in this public consultation. We want to hear from you, because we want our policy proposals to be as effective and efficient as possible. As you can see, it takes time to develop a regulatory and supervisory approach. But it is not new for regulators and supervisors to have to deal with regulatory catch-up. This is inherent to a landscape that supports financial innovation. Nevertheless, the speed of developments in the crypto eco-system, including the recent market turmoil, has given us all the more reason to develop an appropriate and globally consistent regulatory framework. Catching up with the rapidly changing environment is therefore our highest priority. A catch-up that strengthens the stability of the financial system. A catch-up that strongly underpins the public's trust in a system that has developed and evolved over many centuries. The Bank of Amsterdam offers an inspiring example of how financial innovations can advance an economy – and of how things can turn out badly. It is the FSB's goal to learn from the past – and to stimulate innovations that improve the global financial system, while also advancing and protecting its stability. Crucial in this regard, is adequate regulation, and supervision, of governance, risk management, and 4/5 BIS - Central bankers' speeches transparency. These are quintessential elements of a well-functioning financial system that passes the litmus test of the public's trust. I trust you are with me on this. Thank you. 1 The full history of the Bank of Amsterdam, and the lessons it carries for the governance of digital money, has been described by Jon Frost (BIS), Hyun Song Shin (BIS) and Peter Wierts (DNB) in a BIS working paper (No. 902): An early stablecoin? The Bank of Amsterdam and the governance of money 2 I have to credit Carmen M. Reinhart and Kenneth S. Rogoff with popularizing this phrase. In their seminal work – "This Time Is Different" (2009, Princeton University Press) – they have described the 'this-time-is-different syndrome' showing how unrealistic optimism has afflicted bankers, investors and policy makers in the periods leading up to financial crises over the past 180 years. 3 As has been evidenced for example by DNB research titled "the carbon footprint of bitcoin" (2021, DNB Analysis series) or the Cambridge Bitcoin Electricity Consumption Index. 4 See for example the BIS Annual Economic report (2022), Chapter III. 5 For a full overview of the vulnerabilities that have been identified in relation to crypto- assets, please refer to the FSB report "Assessment of Risks to Financial Stability from Crypto-assets" published in February 2022. 6 Full report can be found here. 7 Full report can be found here. 5/5 BIS - Central bankers' speeches | netherlands bank | 2,022 | 11 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the 32nd Frankfurt European Banking Congress, Frankfurt am Main, 18 November 2022. | Speech Klaas Knot - In resolute pursuit of price stability 18 November 2022 General © DNB “For a long time, inflation was hardly on anyone’s mind. But today, it has become a key issue for everyone.” In his keynote address at the 32nd Frankfurt European Banking Congress, Klaas Knot spoke about the ECB’s resolute pursuit of price stability. Datum: 18 november 2022 Spreker: Klaas Knot Locatie: 32nd Frankfurt European Banking Congress, Frankfurt In the run-up to any big football tournament, newspapers, podcasts, and TV presenters overload you with facts and figures, performance levels and prognoses. But amidst all those stats and stories, they usually forget one golden rule: in the end, Germany always wins. At the ECB, we play a different ballgame. But just like in football, to beat the current economic challenges, to normalise inflation, and to safeguard the sustainable welfare of people in Europe, we team up. We defend and strike together. And we won’t forget the golden rule of our game: in the end, we only win if all of us win. For a long time, inflation was hardly on anyone’s mind. But today, inflation has returned with a vengeance and has become a key issue for everyone. Three years ago, in 2019, headline inflation in the euro area stood at a seemingly unshakable 1%. A year later, it even dipped below zero. A mere year ago, as the economy rebounded from the pandemic, headline inflation approached an unprecedented 5%. And yesterday, for the first time in its history, Eurostat reported double-digit headline inflation of 10.6%, and even more worrisome from our perspective, core inflation (excluding energy, food, alcohol & tobacco) reached an all-time high at 5.0%. What is driving this inflation surge? Of course, there are energy prices and one-off factors (Figure 1). But the persistence of high inflation – both headline and underlying – has surprised many experts. ECB forecasters, markets and analysts have kept revising up their inflation forecasts and now expect inflation to peak in the fourth quarter of 2022 (Figure 2). It is projected that inflation will only return towards the ECB’s 2% target in the course of 2024. These forecasts are surrounded by unusually high levels of uncertainty. This means that gauging risks to the inflation outlook becomes particularly important. Overall, these risks remain tilted to the upside. One major risk factor is upward surprises to energy prices due to scarce and uncertain supplies. This is especially the case in Europe. And especially for natural gas, given the ongoing geopolitical risks. Over a slightly longer horizon, there is another upside risk to inflation. Government policies that aim to cushion the impact on households of the high energy prices may be inflationary to the extent that they do not merely target those people that lack the financial resources to pay the higher costs. And of course, there is the very real risk of second round effects, that I will come to later.* At the same time, growth is slowing down. According to the flash estimate, euro area real GDP grew by 0.2% q-o-q in the third quarter of this year. This is down from 0.8% in the previous quarter but slightly higher than expected by ECB staff in September. Looking forward, according to ECB staff forecasts from September, growth is projected to decline further in the fourth quarter of 2022, then come to a standstill, and start recovering in the second quarter of 2023. Incoming soft data since September suggest that the economic outlook has deteriorated further and that the risk of a recession has increased. So, what is weighing down on growth? There are at least four factors: high inflation, high uncertainty, rising interest rates, and the fading effects of the reopening from the Great Lockdown. Slower growth is necessary to bring inflation down, but it is far from certain that slower growth or a mild recession alone will be enough to drive inflation back to levels around 2%. There are two main arguments for being resolute about pursuing price stability. And by being resolute I mean that we will persist in our efforts until we have reached our goal, no matter how difficult this proves. First, in an uncertain environment in which inflation is persistently high and continuously underestimated, high inflation may get entrenched in people’s minds. Let me explain. The longer inflation remains above target, the greater the risk that it will affect firms’ and households’ expectations and economic decisions. These second-round effects would reflect a switch from a regime of “rational inattention” in which firms and households largely ignore inflation numbers, to a regime of “rational attention” with high inflation firmly on their minds. [Note 1] History has shown that this switch is typically sudden. But once this shift occurs, inflation would remain above the ECB’s inflation target for a prolonged period, even when there are no additional inflation shocks. Taming inflation will then become increasingly more difficult and costly. In monitoring risks of second round effects, central banks pay close attention to wage developments and inflation expectations. Subject to the caveat that information on wage formation is not as granular and timely in the euro area as it is for example in the United States, current wage developments do not reveal clear evidence of a wage-price spiral in the euro area. Although nominal wage growth has been picking up, its pace is not sufficient to keep up with rising consumer prices. This said, persistently tight labour markets point to rising risks of a further acceleration of wage growth. Figure 3 shows for the Netherlands that nominal wage growth has indeed been picking up and the forward-looking wage indicator points to higher future wage growth. A new monthly wage growth tracker developed by my colleagues from the Central Bank of Ireland based on job postings also reveals that growth in euro-area posted wages accelerated in 2022 and reached 5.2% year-on-year in October. Besides, the wage tracker shows that like inflation, wage growth has also become increasingly broad-based.[Note 2] We will need to be on high alert for any feedback loop to prices. Moreover, measures of inflation expectations for several types of agents point to mixed evidence on their anchoring to the ECB’s inflation target. For professional forecasters and market participants, mean or median expectations have increased since mid-2021 to levels slightly above 2%. And their sensitivity to short-term inflation expectations has remained stable in recent months. For households on the other hand, both median long-term inflation expectations and their sensitivity to short-term expectations have increased visibly. [Note 3] This suggests a weaker anchoring. When we look at the whole distribution of inflation expectations, however, we can detect signs of a weaker anchoring of expectations not only by households but also by market participants and professional forecasters. Uncertainty and disagreement on future inflation have increased for all agents, and so has the probability they attach to high inflation over the long run (Figure 4). This is a risk we need to monitor. Evidence from the Great Inflation in the 1970s demonstrates why. Up to 1971, the mean of professional forecasters’ inflation expectations in the United States suggested firmly anchored expectations. However, looking at the full distribution of household expectations might have revealed that as early as 1968 the anchor was becoming loose. The increase in disagreement across households and the shift in the skewness of their expectations towards higher inflation were simply overlooked. This proved a costly mistake because they turned out to be a leading indicator of the period to follow when inflation expectations went completely adrift. [Note 4] Aside from the risks of disanchoring inflation expectations, I have a second argument for being resolute in the pursuit of price stability. And this has to do with demand factors in recent inflation dynamics. Obviously, in the euro area context supply factors are highly relevant. But two types of evidence point to an additional, significant role of demand factors. First, inflationary pressures have increased across the board, and not only for energy and traded goods affected by strained supply chains and the war in Ukraine. This broadening of inflation to a wide spectrum of goods and services points to aggregate demand factors also being at work (Figure 5). The second piece of evidence builds on the strong positive association between forecast errors in inflation and output in the euro area. Since the second half of 2021, not only has inflation been surprisingly high GDP growth has also consistently turned out higher than expected been surprisingly high, GDP growth has also consistently turned out higher than expected. [Note 5] Figure 6 shows that demand shocks to an important extent explain these inflation surprises. [Note 6] So now that I have elaborated on the risks to the inflation outlook, the logical question follows: how to bring it down? I would begin by recalling that we have already taken important steps. Persistently abovetarget inflation in combination with clear upside risks led us to normalise our monetary policy stance so that demand becomes better aligned with reduced supply. In December 2021, the Governing Council decided to discontinue net asset purchases under the PEPP by the end of March 2022, and bring APP purchase volumes back, as soon as possible, to pre-pandemic levels. In July 2022, net purchases for the APP were ended. Since then, policy rates have been raised by 200bps. And the Governing Council also decided to change the terms and conditions of the TLTRO-III operations. This was needed to ensure its consistency with the broader normalisation process and to reinforce the transmission of our policy rate increases to bank lending conditions. All our instruments need to work in the same direction. Looking back, we did not know exactly where monetary policy was headed, but we were sure that we had to leave accommodative territory as soon as possible. In football terms, our tactics reflected some sort of kick-and-rush spirit, with rate hikes of 50bps and 75bps reflecting the desire to front-load our action and reach a more neutral stance of our policy rates as soon as possible. Looking forward, I expect us to reach broadly neutral territory at next month’s policy meeting. At that moment, we are no longer stimulating economic growth, but we are also not yet slowing it down. Neutral territory is like halftime in a football game, when coaches gather all their players around a white board and draw the game plan for the second half. The team that comes back on the field might then play in a different way, for example more tiki-taka than continued kick-and-rush. For the ECB, the overall game plan remains obvious. Our response needs to be resolute, implying that monetary policy needs to enter restrictive territory to dampen demand. We need to address high inflation persistence and growing risks of it becoming entrenched in people’s minds, which would make inflation more costly to tame. How fast and far ongoing rate increases will bring us into restrictive territory is surrounded by uncertainty and will be evaluated meeting by meeting. As the stance of monetary policy tightens further, it will become more likely that the pace of increases will slow. In any case, our priority going forward will be the need to rule out the risk of persistently high inflation. This also reflects the switch to more varied tactics, with more instruments coming into play. The level to which the policy rate will be increased also depends on the calibration of these instruments, such as the roll-off of our bond holdings. It would not be consistent to keep a large balance sheet to compress the term premium, while at the same time tightening policy rates above neutral. Once more, all our instruments need to work in the same direction. There are clear benefits of such a well-balanced tightening package. From a stance perspective, passively rolling off our bond portfolios in addition to raising the short-term rate, helps to transmit the tighter policy stance more evenly to the real economy. Model simulations conducted by DNB staff show that an earlier start of so-called Quantitative Tightening (QT) lowers both peak inflation and the required terminal rate via its effect on the term premium. When thinking specifically about QT, our decisions should rest on four principles. First, policy rates should remain the primary instrument to adjust our monetary policy stance. Our balance sheet size should act as a “backburner” tool. Second, APP holdings should be distinct from PEPP holdings. The former exclusively steers the monetary stance, while PEPP continues to serve a dual purpose, by also countering fragmentation risks to monetary transmission. Therefore, decisions about unwinding these two programmes do not have to run in parallel. I expect the APP roll-off to start significantly earlier than that of PEPP, for which reinvestment is communicated to last until the end of 2024. Third, I see a case for caution. To me, this calls for an early but partial stop to reinvestments, to test the waters before calibrating the ultimate pace of the roll-off. And finally, QT should be predictable, like watching paint dry, as the saying goes. [Note 7] Let me sum up. “Football is a simple game. Twenty-two men chase a ball for 90 minutes and at the end, the Germans always win.” Dixit Gary Lineker, former striker for England. The game we are currently playing is approaching halftime. And so far, the ECB has used several tactics to beat its opponent. Between December 2021 and today, we started normalizing monetary policy. We did this by discontinuing net asset purchases under the PEPP, reducing APP volumes to pre-pandemic levels, and eventually ending all net purchases. And then we scored long-shot goals with interest rate hikes of 50 and 75 basis points. As we head into the second half, our game plan is likely to change from long shots on target to short passes and agile moves. So, it will become more likely that we slow the pace of interest rate increases, which also enables us to use the full palette of our instruments making our tactics more varied. Our goal still being that we want to rule out the risk of persisting high inflation and avoid it becoming entrenched in people’s minds. Gary Lineker was not far from the truth when he uttered his famous quote. But it makes you wonder why. And I think it comes down to the dedication and determination of the Mannschaft. To giving it all you have got. To play the game until the very final whistle. And rest assured, this is exactly what the ECB will do. Notes [1] The hypothesis of rational inattention has been discussed recently by J.H. Powell (2022). Monetary policy and Price stability . Speech delivered at “Reassessing Constraints on the Economy and Policy,” an economic policy symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, 26 August 2022. The analysis of rational inattention goes back to C. Sims (2003). Implications of Rational Inattention . Journal of Monetary Economics 50 (3): 665–90. For an in-depth discussion, see e.g., Coibion, O. and Y. Gorodnichenko (2015). Information rigidity and the expectations formation process: A Simple Framework and New Facts . American Economic Review, 105 (8): 2644-78. [2] P. Adrjan and R. Lydon (2022). Wage Growth in Europe: Evidence From Job Ads. Economic Letter. Central Bank of Ireland. November 2022. [3] Evidence for Dutch households is presented in G. Galati, R. Moessner and M. van Rooij (2022). Reactions of household inflation expectations to a symmetric inflation target and high inflation . DNB WP 743. [4] This point was stressed by R. Reis (2021). Losing the Inflation Anchor . Brookings Papers on Economic Activity, Fall and picked up by I. Schnabel (2022). Monetary policy and the Great Volatility . Speech at “Reassessing Constraints on the Economy and Policy,” Federal Reserve Bank of Kansas City, Jackson Hole, 27 August. [5] This phenomenon has been documented for the euro area by a recent analysis by ECB and DNB staff, for the United States and more generally advanced economies by the IMF in the recent WEO. See E. Gonçalves and G. Koester (2022). The role of demand and supply in underlying inflation – decomposing HICPX inflation into components . In ECB Economic Bulletin, September; International Monetary Fund (2022). World Economic Outlook, October 2022: Countering the Cost-of-Living Crisis. Washington, D.C. [6] E. Gonçalves and G. Koester (2022). The role of demand and supply in underlying inflation – decomposing HICPX inflation into components . In ECB Economic Bulletin, September; International Monetary Fund (2022). World Economic Outlook, October 2022: Countering the Cost-of-Living Crisis. Washington, D.C. [7] See J. Yellen (2017). Transcript of Press Conference, 14 June , and P. Harker (2017). Economic Outlook: The Labor Market, Rates, and the Balance Sheet . Remarks at the Market News International (MNI) Connect Roundtable, New York, NY, 21 May. | netherlands bank | 2,022 | 11 |
Speech (virtually) by Mr Klaas Knot, President of the Netherlands Bank and Chair of the Financial Stability Board, at the 11th ILF Conference on the Future of the Financial Sector "The Next Systemic Financial Crisis – Where Might it Come From?": Financial Stability in a Polycrisis World, at the Goethe University's Law and Finance Institute, Frankfurt am Main, 24 January 2023. | Klaas Knot: Daring to know in times of uncertainty and structural shifts Speech (virtually) by Mr Klaas Knot, President of the Netherlands Bank and Chair of the Financial Stability Board, at the 11th ILF Conference on the Future of the Financial Sector "The Next Systemic Financial Crisis – Where Might it Come From?": Financial Stability in a Polycrisis World, at the Goethe University's Law and Finance Institute, Frankfurt am Main, 24 January 2023. *** Hello everyone. This beautiful wood engraving (Note 1) depicts a scene in 1794. You can see four welldressed men, sitting in a flourishing garden in Jena – a city a few hours east from Frankfurt. The four men are sitting around a table, filled with wine and grapes– and they appear to be engaged in a civilized discussion. The four men on the drawing are the brothers Wilhelm and Alexander von Humboldt, respectively statesman and explorer, the poet Friedrich von Schiller and, of course, scientist, writer and poet, Johan Wolfgang von Goethe. The four of them were the intellectual fab four of late 18th century Germany. They strongly believed in the powers of reason – as opposed to royal decrees or religious dogmas. They strongly believed that individuals were to be enlightened – through science, art, and literature. They strongly believed in "sapere aude" – in daring to know. I was asked to talk about systemic risks today. More precisely, about where the next systemic financial crisis might come from. And truth be told – this is hard to say. We can't predict that with any reliability. One only needs to recall the way that the covid pandemic hit us to know that a crisis can emerge unexpectedly. This is exactly why predicting the next crisis is not what we aim to do at the Financial Stability Board (FSB). Instead of predicting, our aim is to approach financial stability with a different way of thinking. Financial stability is the capacity of the global financial system to withstand shocks, by containing the risk of disruptions in the financial intermediation process that would be severe enough to adversely impact the real economy. In short: our work is about enhancing the resilience of the global financial system. So that, when the next crisis materialises, the system as a whole can cope with it. In order to increase that resilience, we try to know as much as possible about the vulnerabilities in our financial system. And we do this by relying on the powers of reason, logic, cooperation and data. In other words, by following the brothers von Humboldt, Friedrich von Schiller, and Johan Wolfgang von Goethe in sapere aude. So how do we go about that? 1/6 BIS - Central bankers' speeches To increase the resilience of the global financial system and to enhance financial stability, we rely on the FSB's financial stability surveillance framework. Let me start by walking you through this framework, and then I will illustrate how we apply it. The FSB's financial stability framework is based on four guiding principles. First, we need to identify the vulnerabilities that may threaten global financial stability. I say 'vulnerabilities' instead of 'shocks' or 'risks'. That is intentional. The pandemic is a shock. The war in Ukraine is a shock. A rapid shift in financial market conditions would be a shock. Shocks are by definition unpredictable – so they don't offer a solid starting point for financial stability policy. Risk – that is the risk of a shock large enough to have a financial stability impact – is similarly very difficult to assess. Vulnerabilities, on the other hand, can usually be measured, at least to a certain extent. Think for instance about the build-up of imbalances, like a rise in leverage during a credit boom. And so, they do offer a starting point for financial stability policy – policy that is aimed at reducing these vulnerabilities. Through this approach we can mitigate potential systemic disruption, once a shock hits our global, highly interconnected financial system. And so, in the spirit of Alexander von Humboldt, who measured and mapped large parts of the world, we, in turn, try to map and measure global vulnerabilities – rather than the shocks that may or may not materialise. Second, once mapped and measured, we monitor these vulnerabilities, taking into account the potential interactions between them. We also deploy a forward-looking perspective, by considering emerging vulnerabilities in addition to current ones. It is better to prevent vulnerabilities from growing in the first place, rather than having to reduce them once they already pose a global threat. Our third guiding principle is that we recognise the differences among countries. The FSB's membership reflects the diversity of our global financial system, with members from both emerging market and advanced economies. And these differences are reflected in our assessment of vulnerabilities. We fully recognise that some vulnerabilities may be more relevant for emerging market economies, and others for advanced economies, or for different sets of jurisdictions. For example, the urgency policymakers ascribe to some of the risks relating to cryptoassets and crypto-markets differs across countries. In some economies, the most pressing concern is the potential loss of monetary sovereignty. In other economies, the risks of money laundering and fraud are perceived to be more urgent. The fourth and final guiding principle, is that the FSB leverages on this diversity of its membership. There lies tremendous strength in that diversity. FSB members not only come from different kinds of economies, but they are also represented by different kinds of authorities: ministries of finance, central banks, and securities and market authorities. 2/6 BIS - Central bankers' speeches Our members also include global standard-setting bodies and international organisations. Many of those members carry out and publish financial stability assessments. The FSB's vulnerabilities assessment therefore builds on those analyses. With these four guiding principles, I have given you a brief and mainly theoretical outline of the FSB's financial stability surveillance framework. I hope that this approach, this way of thinking about how to enhance the resilience of the global financial system, provides you with some stimulus for today's discussions. But what does it look like when we actually apply this framework? To illustrate this, allow me to touch on several of the key FSB priorities that are also on your agenda today. First, I will focus on the cyclical vulnerabilities that emerge from the current outlook. The combination of rising inflation, tightening financial conditions and the fallout from Russia's invasion of Ukraine has led to a synchronised slowdown in global economic activity. This is occurring against a backdrop of high levels of debt of households, nonfinancial corporates and sovereigns. The latter implies that some governments have limited fiscal space to provide additional targeted policy support. And given the increases in inflation, central banks also have less policy space to react to financial stability shocks. Although this outlook is challenging, so far the global banking system has shown itself to be resilient. Global financial markets have largely coped in an orderly manner, with limited and temporary support when necessary. And systemic financial institutions have shown resilience to market strains – in large part due to the financial reforms, following the 2008 Global Financial Crisis, that were coordinated through the FSB. However, there is no room for complacency. Financial institutions and market participants have not experienced sharply rising interest rates for a long time. Very low interest rates may have become embedded in business models, making the adjustment to a world of higher rates challenging. Companies and households that have borrowed money will also need to adjust to higher interest payments, and problems may materialise only with a lag. So, we need to remain vigilant. A deterioration of banks' asset quality may still occur, and other vulnerabilities, like the ones on today's agenda, need to be monitored closely. Some of these vulnerabilities may have been previously prevented from materialising by authorities' COVID-19 support measures. But now these measures are being lifted. So it is important to address debt overhang issues of non-financial corporates, and to respond to potential issues of underinvestment due to excessive indebtedness or misallocation of resources to unviable companies. All of these are what I would call cyclical vulnerabilities. But, more fundamentally, we also need to be wary of vulnerabilities that stem from structural shifts in the global financial system. 3/6 BIS - Central bankers' speeches So allow me to say a few words on three structural shifts that the FSB is currently focusing on, and the associated vulnerabilities. It is, of course, no coincidence that the topics of today's panels overlap with many of the FSB's priorities. First – the structural shift in the provision of finance from banks to non-banks. In our Global Monitoring Report on non-bank financial intermediation, from December 2022, we highlighted that the NBFI sector reached 239 trillion US dollars in 2021. If a number on that scale is hard to put into context, a more telling figure is perhaps that the NBFI sector increased its relative share of total global financial assets to 49% in 2021, compared with 42% in 2008. Almost half of all global financial assets are now being intermediated by non-banks. While diversifying the sources of credit can make the global economy more resilient, the growth in NBFI has exposed important vulnerabilities in the non-bank sector. We have seen the problems that these vulnerabilities can cause several times in recent years: for instance, the 'dash for cash' episode during the onset of the pandemic, the strains in commodity markets last year, and more recently the challenges faced by UK pension funds. Thankfully, these strains have proved temporary, but only after massive official sector interventions were deployed. These examples therefore serve as a warning to remain vigilant on the recurring themes of leverage, including hidden leverage, liquidity mismatches, and data gaps. The FSB's NBFI work programme and policy proposals aim to address these vulnerabilities. In 2023, we will continue to focus on some key vulnerabilities within the sector. Apart from monitoring systemic risk in NBFI, we will review the effectiveness of our money market funds policy proposals from 2021; revise our recommendations from 2017 on liquidity mismatches in open-ended funds; and conduct follow-up work on margining practices and hidden leverage in NBFI. A second structural shift we have witnessed, is the digitalisation of finance. This comes in many shapes and forms, but I will focus on the rapidly developing crypto-asset ecosystem. Crypto-asset markets and activities bear a multitude of risks and vulnerabilities. While the technology behind crypto-assets is often being promoted as game-changing, the vulnerabilities associated with them are in fact quite similar to those we know from traditional finance. Liquidity mismatches, hidden leverage, and counterparty credit risk are all examples of well-known financial risks that have also materialised in crypto-asset markets in the past year. National regulatory authorities have recognized that these activities are in essence financial activities and have begun regulating them. This is challenging for national authorities, however, because crypto-asset markets are inherently global in reach. So, in the presence of structural vulnerabilities and in the absence of globally consistent regulation, the FSB is concerned crypto-asset markets may soon pose a challenge to global financial stability. 4/6 BIS - Central bankers' speeches The FSB therefore concluded that crypto-asset activities and markets must be subject to effective regulation and oversight commensurate to the risks they pose, both at the domestic and international levels. To this end, the FSB proposed a comprehensive global framework for the effective regulation of crypto-asset activities, including stablecoins, in October last year. This framework embeds the principle of 'same activity, same risk, same regulation'. Finalising these recommendations and monitoring their effective implementation across all jurisdictions will be a priority for the FSB in 2023. Of course, the FSB does not operate alone. Just like in the traditional financial sector, there is a myriad of functions that the crypto asset ecosystem covers or otherwise touches. So it is key to have solid cooperation between the different standard setting bodies, all with their different mandates. Third – it is impossible to talk about systemic risk without mentioning one of the most fundamental challenges of our time: climate change. This third structural shift is not on the agenda today, but the events of the past year have again emphasised the importance of addressing these vulnerabilities. The volatility in energy markets, exposures to hard-to-predict physical risks and the challenges of the transition to net zero are all examples of vulnerabilities that have an impact on the financial sector. So addressing the financial risks stemming from climate change is, and will remain, high on the FSB agenda. One way we are working on this, is with our roadmap. With that roadmap, we are coordinating the international efforts to address climate-related financial vulnerabilities. It consists of four key elements: disclosure, data, vulnerability analysis and supervisory and regulatory tools. One of the main priorities is the reliability and consistency of data, because that is what good risk management starts with. A key priority for this year is the finalisation and implementation of a global climate-related disclosure standard. Other priorities are analysing the use of transition planning and the improvement of our framework for monitoring climate-related vulnerabilities. Let me wrap up. NBFI, crypto and climate-related financial risks – these are just three priorities for the FSB and the global financial system I wanted to touch on today. But for every risk or vulnerability we focus on, be it cyclical or structural, the same principle applies: the FSB diligently maps, measures and monitors all threats to the stability of our global financial system. We provide a global, cross-border, cross-sectoral and forward-looking perspective on the vulnerabilities we identify. And we do this by drawing on the collective perspective of the broad membership of the FSB. 5/6 BIS - Central bankers' speeches And this way of working, fearless and in the spirit of "sapere aude", does not allow me to predict where the next systemic crisis might come from, but it does allow us to enhance the resilience of the global financial system, to whatever may come its way. In that spirit, the FSB decides where coordinated action is required, monitors the effects of its actions, and assesses where further adjustments are needed. Or, as Goethe said: "Knowing is not enough; we must apply. Willing is not enough; we must do." The four men in the wood engraving I talked about at the beginning continue to be an inspiration today. Each with their own merits – and together, as an example of how reason advances humankind. After Friedrich von Schiller's death, and as an introduction to the correspondence between the two men, Wilhelm von Humboldt wrote an essay on his close association with the famous poet. And in that essay, he stresses the importance Schiller attached to conversation – to how conversation, expressing ideas, exchanging views, ultimately leads to deeper understanding. To how conversation, you could say, embodies "sapere aude". Or in Schiller's words: "Erkühne dich, weise zu sein". And this is just the kind of conversation I hope you will have today. Thank you. 1 "Schiller, Wilhelm and Alexander von Humboldt and Goethe in Jena" (Event date: 1794, image date: 1860). Wood engraving after drawing by Andreas Müller (1831-1901). 6/6 BIS - Central bankers' speeches | netherlands bank | 2,023 | 1 |
Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, at a meeting with members of the Standing Parliamentary Committee for Finance, The Hague, 24 November 2022. | Klaas Knot speaks with MPs about inflation November What has caused the recent sharp rise in inflation, and where is it heading? And what is the European Central Bank doing to bring inflation back to the 2% Meeting with Standing Parliamentary Committee for Finance, 24 November: What are the factors behind the current rapidly rising inflation? We are coming out of a lengthy period of low inflation. Between 2011 and mid-2021, euro area inflation averaged 1.2%, which is below the ECB's price stability target of 2%. The ECB's monetary policy was therefore very accommodative for a long time, with the additional aim of preventing self-reinforcing effects via falling inflation expectations and deflation. Inflation subsequently rose sharply for various reasons. Starting in the first half of 2021, COVID-19 lockdowns led to shortages of manufacturing resources such as computer chips along with higher costs for container transport. This resulted in price hikes that also hit consumers directly starting in the summer of 2021. Energy prices began to rise in late 2021. Inflation was boosted further when the economy reopened in early 2022, with demand for goods and especially services recovering strongly and outpacing supply. Russia's invasion of Ukraine then caused natural gas prices in Europe to skyrocket and food prices to soar. These factors came in rapid succession and persisted for longer than anticipated. Consequently, inflation has now been high for longer and has gradually spread from energy to food, industrial goods and services. Inflation in the Netherlands has now reached 16.8% (in the euro area: 10.6%) in October. The price increases of energy and food are the most remarkable. More than two thirds of harmonised HICP inflation can be ascribed to energy and food. Expressed in percentages: of the 16.8% HICP inflation in the Netherlands, almost 12 percentage points are accounted for by energy (9.7 points) and food (2.2 points). © DNB The calculation method used by Statistics Netherlands creates an upward distortion of Dutch inflation in the order of 3-4 percentage points. This distortion is largely time-shifted: consumers with fixed energy contracts will also eventually face higher gas prices. Where do we see inflation going? The exceptional economic circumstances are creating great uncertainty about the future path of inflation. ECB projections call for euro area inflation to remain high in 2023, only approaching levels near 2% in 2024. Related upside risks are linked to Russian gas supplies and European demand for gas both this winter and in the winter of 2023-24. The profound influence of energy prices means that the central bank has difficulty controlling current inflation. Wage growth along with the increase in the minimum wage also pose an inflationary risk. One-off wage hikes are logical in the face of high inflation, but automatic wage indexation will make it all the more difficult to bring inflation down. Finally, prolonged expansionary fiscal policy can boost inflation further. Efforts to curb inflation are helped when fiscal policy works in the same direction as monetary policy. Economic growth in the third quarter of this year was -0.2% in the Netherlands and +0.2% in the euro area (quarter-on-quarter). DNB will issue new projections in December. It is quite possible that we will also experience economic contraction in the coming quarters. Some cooling off of the economy is needed to reduce inflationary pressures. However, it is far from certain that a mild recession will be enough to curb high inflation. What is the ECB doing about this? The ECB is taking unprecedented measures to restore price stability. The ECB embarked on the course of normalisation in December 2021. At the time, inflation was already above target but was still expected to fall below 2% again in the medium term. The war in Ukraine and broadening inflationary pressures prompted the ECB to accelerate monetary policy normalisation. Net asset purchases have since ceased (the Pandemic Emergency Purchase Programme (PEPP) in March and the Asset Purchase Programme (APP) in July) and the ECB has raised policy rates three times. The two most recent rate hikes (of 0.75 percentage points) were the ECB's largest rate hikes ever. Monetary policy is expected to tighten even more in the coming months, thus raising interest rates further beyond neutral levels. © DNB Current monetary policy is geared towards curbing demand, thus keeping inflation expectations anchored. The ECB is using higher interest rates to bring demand in line with more limited supply, thus creating a balance that will contribute to price stability. The rapid pace at which interest rates have been raised is linked to the pace at which inflation has increased and underlines the ECB's commitment to price stability in line with its mandate. The ECB will continue to tighten its policy until the medium-term outlook for inflation – a broader concept than just model projections – returns to target. Monetary policy in 2022 is about more than just policy interest rates: the balance sheet of the Eurosystem will also be examined. To mitigate the risk of deflation or another financial crisis during the pandemic, the ECB purchased bonds on a broad scale and provided loans to banks under favourable conditions in recent years. With monetary policy being tightened, these instruments are also being adjusted. Conditions for TLTRO loans were recently tightened, and in December we will discuss the scale-down of the bond portfolio that we plan to start next year. At the same time, the ECB can use the Transmission Protection Instrument (TPI) to prevent disruption to the smooth transmission of its policies in the euro area. The ECB Governing Council can activate the TPI and temporarily resume bond purchases if it identifies disorderly market conditions while fiscal policy still meets all agreed conditions. There has thus far been no need to deploy the instrument. How does this affect DNB's balance sheet and profitability? Monetary tightening will lead to expected losses for DNB (as explained in my letter to the Minister of Finance on DNB's capital position, dated 9 September 2022). We will absorb losses by drawing on our buffers and our provision for financial risks. It is worth noting in this regard that central banks outside the euro area, even those with a different monetary strategy, are also expecting significant losses due to current market developments. DNB's loss should be seen in broader perspective. Making a profit or loss is inherent to the conduct of our tasks as a central bank. The expected losses stem from monetary measures that have produced major public benefits. For example, our shareholder, the Dutch State, benefited from savings on interest payments estimated at EUR 28 billion between 2015 and 2021, which is significantly more than the profit distributions that are expected to fall by the wayside in the coming years. Impact of rising interest rates on debts The effects of monetary tightening are visible in sharply higher bond yields and mortgage lending rates, which leads to higher financing rates for households and businesses. The relatively high level of household debt in the Netherlands is a vulnerability. Financial risks may materialise if outstanding debts need to be refinanced or if house prices fall. There are clear signs of a turnaround in the housing market. Some cooling in the overheated market is desirable, but a fall in house prices could have negative macroeconomic effects as consumption declines. The financial position of homeowners is healthier than prior to the 2008 financial crisis. Among other factors, mortgage debt repayments have reduced the average loan-to-value ratio. As a result, households are generally less likely to go into negative equity ("under water") if house prices fall. (Financial Stability Report, – autumn 2022). In addition, many households have taken advantage of the low interest rate environment to lock in a long fixed-interest period, meaning most of them will be able to weather a potential negative equity situation for just as long. The Dutch public debt-to-GDP ratio is developing favourably, but it is important to restore fiscal discipline. As mentioned earlier, large-scale and generic fiscal policy can lead to higher inflation, higher interest rates and higher public debt. High public debt in some Southern European member states poses a risk, although even here the impact of rising interest rates on public finances is cushioned by the fact that public debt is financed on a long-term basis. If economic growth weakens, doubts about debt sustainability in countries with high debt-to-GDP ratios could resurface. | netherlands bank | 2,023 | 1 |
Opening speech by Mr Klaas Knot, President of the Netherlands Bank, at the Climate Risk Conference, organised by the National Bank of Slovakia, Bratislava, 7 February 2023. | Klaas Knot: What can central banks do to help save our planet? Opening speech by Mr Klaas Knot, President of the Netherlands Bank, at the Climate Risk Conference, organised by the National Bank of Slovakia, Bratislava, 7 February 2023. *** "In Slovakia, 42% of young people are very worried about the climate crisis. 73% think humanity has failed to look after our planet. Two thirds find politicians' actions to address the climate crisis disappointing. A recent study carried out in a number of other countries has shown that 40% of young people are considering not having children because of the climate crisis. It is clear: the next generation knows we are running out of time." Those were the words of your President, Zuzana aputová ( spreek uit: tsjaputová) at the United Nations Climate Change Conference in Glasgow. Words that deeply impressed me. As a world citizen, as a central banker, and – even more – as a father. It is not often that statistics are so vivid, so visual – even though our economists' hearts always think they areShe was so right: the climate crisis is a crisis that is all-enveloping and one we have seen coming for a long time. That's what sets this crisis, this challenge, apart from other challenges we are facing: we could have seen it coming, but we sat on our hands and stared at each other instead of taking action. And now we are running out of time. So, as your President stated: "We must double down on our efforts to mitigate the impact of the climate crisis to reverse the devastation of our planet." It was obvious she was not talking about tomorrow, but about today. To show young people, our children, that our generation also knows we are running out of time. Of course, her call to action was addressed at politicians, not at central bankers, but I am convinced that we also have an important role to play. That was also the conclusion we reached in my first year as President of the Dutch Central Bank in 2011. During a teambuilding weekend at sea we, my colleagues on the Executive Board and I, talked about our goals, our view for the future. The future of the bank, and the future of the financial sector. That was necessary, because in 2011 the financial sector and our economy were recovering from the blows of the financial crisis. A crisis that, in addition to costing a great deal of money, had also cost citizens' confidence in banks, in the financial sector. We had to restore that confidence. For our citizens and our sector, for our economy and for our future. The question was how? We decided that our mission as a central bank and as a financial supervisor should focus more on our contribution to sustainable prosperity and hence, sustainable finance. We decided that we would choose to emphasise the long term instead of the short term. To look beyond financial welfare to well-being, to look beyond mere economic growth to inclusive, sustainable growth. Because we were convinced that sustainability was a prerequisite to restore confidence, a prerequisite to safeguard the future. For our citizens and for the financial sector. 1/4 BIS - Central bankers' speeches Eleven years ago, that was – if I may say so myself – a bold decision, because sustainability was not mainstream, not on every agenda. But what could and can a central bank, wat can we do, to help save our planet? Definitely not everything. We are not elected politicians. We are not in the driving seat, but definitely part of the team. A part of the team in three different ways, in three different roles. As a supervisor and regulator, as a long-term economic adviser and as a leader by example. To start with the obvious: as a supervisor and regulator we have a responsibility to address macro- and microprudential risks and thereby contribute to financial stability. In this capacity we can help guide financial institutions to identify, recognise and mitigate risks, and - should risks materialise - prevent them from having serious consequences. To give a few examples: we have developed a climate stress testing framework for transition risks, which we will expand this year to include a focus on physical risks. Also late last year, DNB published a guide with good practices to control climate- and environment-related risks. This guide was particularly aimed at insurers and pension funds and in line with the ECB's 2020 guide aimed at banks. It seeks to provide financial institutions with constructive good practices to help with their risk management. In the near future, we aim to integrate climate- and environment-related risks into our 'regular' periodic supervision. Our role as a long-term economic adviser is – of course – based on accumulated knowledge, on data and facts: we are central bankers, not philosophers. Before we tackle a problem we have to understand it, and in order to understand it, we have to quantify it. So we accumulate essential data to monitor developments in order to take effective decisions. We do that as a national central bank but especially tandem with the ECB and FSB. For example, statisticians from central banks in the euro area have recently been working hard with the ECB to generate sustainability data. Data that indicate the carbon footprint of the financial sector's investments, which can be used to gauge the degree of exposure of the sector to transition risks. Data that indicate 'physical risks' due to climate change through loans and investments. Data that indicate the extent to which financial institutions have invested in bonds aimed at promoting sustainability, the socalled green bonds. Of course, these data are not yet complete, but they are urgently needed. Today, not tomorrow. Because we need to know as much as we can to take on our role as long-term economic advisers. Not only for the financial institutions we supervise and advise, but as policy advisers for our governments. Nationally and internationally. 2/4 BIS - Central bankers' speeches Because they have to take the lead in the transition that must take place. They have to develop and enforce a clear climate policy. They have to take the responsibility to enable and inspire the sustainable choices we must all make. Tough, major choices will have to be made: between intensive farming and nature, between fossil fuels and green energy, between heavy industry and air quality. We can help to make that happen. In our role as forward thinkers. Especially because 'forward' means to me: independent and for the long term, not under the influence of voters, not just until the next elections. That is an important role we have to invest in: to be that angel or devil, or the Jiminy Cricket on the shoulder of our politicians, whispering in their ears – or pulling themTo make sure that sustainable choices are not only made, but are successfully stimulated and implemented. And that takes us to our third role: a leader by example. As an organisation we can and must set an example, we must make our own sustainable choices. For instance in our payment systems, in our monetary operations and of course in our own investments as a central bank. That is our responsibility as a central bank. That is why I am proud that DNB was the first central bank to sign the Principles for Responsible Investment in 2019. This marked the start of our journey towards the integration of responsible investment in our own-account portfolios. In our internal operations, too, we try to be as sustainable as possible in the choices we make, for instance in the renovation of our headquarters building. In the choice of materials and in the choice of solutions for energy consumption. For example: we made the old concrete carbon-neutral by injecting it with CO2. That is a world-first. We will also have a lot of greenery in and around our building, and up on the roofs. We will place nesting boxes and insect hotels in those green areas. These features will help our building contribute to biodiversity, right in the heart of Amsterdam. We are doing all this not only to help the transition, to do our bit to save our planet, but also to set an example, a practical example. For the financial institutions we supervise, for our clients and partners, and for the people in our country and in the rest of Europe. Because the transition we need is not only a matter of policy, of rules and regulations. The transition we need is fuelled by change, by changing people's minds and behaviour. By encouraging and inspiring people and businesses to think and act differently, to make different choices. That is why it is important that you are all here to talk about what we can do to advance the transition to sustainability. 3/4 BIS - Central bankers' speeches To talk about how to take up our roles as supervisors and regulators, as long-term economic advisers and as leaders by example. About how to double down on our efforts to mitigate the impact of the climate crisis to reverse the devastation of our planet, as your President said in Glasgow. All while keeping in mind that saving the planet is a team effort. Or as sir As David Attenborough said during that same Climate Summit in Glasgow: "If working apart, we are a force powerful enough to destabilise our planet, surely, working together, we are powerful enough to save it." 4/4 BIS - Central bankers' speeches | netherlands bank | 2,023 | 2 |
Keynote speech (digitally) by Mr Klaas Knot, President of the Netherlands Bank, at MNI Market News, London, 8 February 2023. | null | netherlands bank | 2,023 | 2 |
Text of the Whitaker Lecture by Mr Klaas Knot, President of the Netherlands Bank, Dublin, 19 April 2023. | Klaas Knot: Striving for financial stability Text of the Whitaker Lecture by Mr Klaas Knot, President of the Netherlands Bank, Dublin, 19 April 2023. *** Thirty years ago when I was just a 'lad', I travelled to Ireland for the first time. I was charmed by your country and your people. By the 'black stuff' [Guinness] and the mournful and uplifting songs which I could enjoy in every pub. By your green and rolling hills, your rugged coasts and numerous lakes. I learned that one Guinness a day keeps the doctor away. And I learned the hard way that in Ireland you can experience all four seasons in one day. Your 'desperate weather' caught me out several times. Not so different from the Netherlands, where an umbrella always comes in handy. Our obsession with our very changeable weather is one of the many things that connect our countries, that connect our economies: we know how to live in the sunshine, but are always prepared for rain. And that is not a bad place to start if you are striving for financial stability. Although sometimes you have to fight the desperate weather and force the sun to shine. That was exactly what Thomas Kenneth Whitaker did when he initiated the Programme for Economic Expansion in 1958. When Whitaker became Secretary of the Department for Finance, the Irish economy was isolated and uncompetitive. Emigration was almost on par with the birthrate. The economic weather was truly desperate. With his Programme, Whitaker let the sun in by opening up the Irish economy to foreign investments and industrial development, including joining the EU, and ending its dependence on agriculture and tariffs. He wrote: "The programme of economic development contained in this White Paper has been prepared in the conviction that the years immediately ahead will be decisive for Ireland's economic future." And decisive they were. The weather improved dramatically, and by the end of his career, Ireland had an open and growing economy, based on foreign trade and investment, and was about to enjoy one of the most productive decades in its history. Whitaker steered Ireland towards the warm economic climate that reared the Celtic Tiger and made it roar. But in opening up your economy, by opting for internationalisation and integration, you made a choice. A choice that affects the ability to regulate financial stability. A choice in what is known as the financial trilemma. Because financial stability, financial integration and national financial policies are incompatible. You can have two out of three, but not all three at the same time. You cannot use national policies to regulate global systemic banks without forcing them to divide capital, and without authorities to divide regulation and supervision between home and host countries. 1/4 BIS - Central bankers' speeches A scenario that counteracts the benefits of financial integration, such as the greater risk diversification and more efficient capital allocation, that can be achieved by those global systemic banks. Benefits that are important for a small, open economy like Ireland. And the Netherlands. Because that is another thing the Celtic Tiger and the Dutch Lion have in common: we are both small, open economies, with a relatively large financial sector, and that makes us both strong and vulnerable. For both our countries, openness is the only way to prosperity – as Governor Whitaker would probably remind us – so the only choice we have is accept the cost of being vulnerable to external shocks. Or more aptly, as Whitaker wrote in Economic Development, "the readiness to adapt to changing conditions". As tigers and lions together, we know that we must be prepared to handle a 'cat's day' every day. As central bankers and supervisors, we are responsible for financial stability. And the main financial stability risks we face at the moment are global risks. That means that even if there is 'dew on the grass', we always have to be on the lookout for the 'cliffs and towers in the sky'. Those cliffs and towers do not only take on the shape of traditional risks like inflation, tightened financing conditions, and risks of asset price corrections, but can also take on new, emerging shapes, like the systemic risks posed by NBFIs. This is why the Financial Stability Board is undertaking significant work on NBFIs. This is why I admire the role of the Central Bank of Ireland as a frontrunner in macroprudential policy for the NBFI sector, as you first introduced a leverage limit for Irish property funds to address the risks stemming from excessive leverage and liquidity mismatch. Some of the cliffs and towers we face have old shapes, shapes we should know and recognise. The turbulence in mortgage backed securities markets confirms that banks tend to neglect risk when interest rates are low for so long. The failure of Silicon Valley Bank shows us that parts of our financial system are still vulnerable to bank runs, despite the worldwide introduction of deposit guarantee schemes. The failure of Credit Suisse due to scandals and bad management confirms that trust must be earned. Both of these events underline that trust is the most important asset that banks can have, the most important weight for balancing financial stability. Confidence and trust are the foundations of any well-functioning financial system, and we all know, or should know, that trust takes years to build, seconds to break and forever to fix. 2/4 BIS - Central bankers' speeches To maintain financial stability we do not only have to adapt to changing conditions, we also have to create the conditions to be able to adapt when stability is threatened. That is why I want to stress the importance of adequate financial buffers: the umbrella that is needed to avoid getting soaked when there is 'a dirty looking sky'. Like the importance of trust, the crucial role of buffers is another important lesson we learned from the Global Financial Crisis. A lesson that we turned into action. The changes in sectoral regulations and supervisory standards have made our financial sector safer and better capitalized. The introduction of the macroprudential framework strengthened its ability to absorb rather than amplify shocks. The resolution mechanism has reduced the cost of winding up financial institutions. All these steps have made our financial sector and our economy more resilient to adverse economic shocks. The robust capital position of the banking sector is part of the reason why a major economic shock such as the COVID pandemic had a limited overall impact on financial and economic stability. That's why I want to emphasise how important it is for European policymakers to fully and comprehensively implement the global tightening of the banking capital framework - as agreed in Basel IV - in the European Union. Especially now. And from my perspective as chair of the FSB it is positive that we are also strengthening the global supervisory framework for non-banks. These institutions must also learn to carry an umbrella. Yes, buffers are essential to consolidate public finances, to ensure financial stability. But not only do we need to be able to adapt to changing conditions and create the conditions to be able to adapt, we also need to be able to bounce back after things go wrong anyway. After 'the big snow'. A prime example of successful snow removal was the consolidation of public finances that Ireland undertook after the Global Financial Crisis. Just how successful Ireland was can be illustrated by a simple comparison with Spain after that crisis. In both countries the public debt to GDP ratio skyrocketed very quickly. The ratio in Ireland went from 30% to 130%, but then came back down to 70%. In Spain, it progressively increased from 30% to 130%, and then stayed there. This underlines that within a monetary union, domestic conditions and domestic policy choices continue to matter, particularly when they relate to fostering productivity growth. Conditions and choices which allowed Ireland to grow out of its public debt problem. That ability to recover is also a key factor for resilience, which is so very vital when new financial stability risks are likely to materialise, and which is especially important for small, open economies. For tigers and lions who have to be prepared to survive desperate weather, a dirty looking sky or a great drying out. For tigers and lions who know that financial stability is an unstable asset. For tigers and lions who live every day with the truth of what Rudiger Dornbusch once said in reference to the Tequila crisis in 3/4 BIS - Central bankers' speeches Mexico "It took forever and then it took a night". That is why tigers and lions prefer to live in a European and global habitat. Because international cooperation, a global approach, is the best way to ensure financial stability, to counter external shocks, to be prepared for changing conditions. To cope with the economic weather. Experience has taught us that global financial stability risks, like any global challenge, are best dealt with using a globally consistent approach. Think of the response to the COVID pandemic. That has shown us how coordinated, fast-paced and effective policy-makers can be when we face a common challenge. For example, the EU-wide loan repayment moratoria scheme made sure that the financial sector provided financial relief, and not financial distress, to households and businesses. The emergency liquidity made available by the ECB preserved smooth financing conditions and ensured that financial institutions in the euro area could continue to support the real economy. The suspension of dividend payments and the release of capital buffers across several countries made sure that banks had sufficient room to absorb losses. In short, international cooperation made sure that banks were not part of the problem, but a very valuable part of the solution. And, looking back at our financial trilemma: completing the banking union would take the financial trilemma to its logical conclusionYes, small, open economies, tigers and lions like Ireland and the Netherlands, benefit from international cooperation and from the ability to predict and adapt to risks. Because we all know: when it comes to financial stability, nothing can be taken for granted. We cannot always predict the weather and we must live with the possibility of having four seasons in one day. Therefore I think that we do not only need broad European and international cooperation, but also cooperation between our two countries, our two central banks, to find common solutions to increasingly common challenges. Because we have a lot in common. And what we don't have in common we can share. As the Irishman Rory Brosnan, who writes about living in the Netherlands, said: "The Irish could do with being 30% more Dutch, and the Dutch with being 20% more Irish." I would make that an even 30%, because that might include the Irish tact, a splash of the black stuff and the ability to sing a good tune. So together we can make sure there is always a rainbow in the sky! 4/4 BIS - Central bankers' speeches | netherlands bank | 2,023 | 4 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Eurofi High-level Seminar 2023, Stockholm, 28 April 2023. | Klaas Knot: Mamma Mia, here we go again? Lessons from Silikon Valley Bank and Credit Suisse Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Eurofi High-level Seminar 2023, Stockholm, 28 April 2023. *** Hello everyone. Yesterday was King's Day in the Netherlands. The day we celebrate the birthday of our king. Having a monarchy is one of the great many things the Dutch and the Swedes have in common. Our King's Day is a national holiday with flea markets on every square, music and beer in the high streets, and the entire country dressed up in orange to celebrate. And every year I think to myself: "Mamma Mia, here we go again." This thought also crossed my mind a few weeks ago, when the most recent episode of market turmoil started – with the failure of Silicon Valley Bank and the fall of Credit Suisse. But are we actually 'going again'? Alfred Nobel provides some wisdom to answer this question. He said: "One can state, without exaggeration, that the observation of and the search for similarities and differences are the basis of all human knowledge." In saying this, he captured exactly what we need to do in case of turmoil, in case of a new shock to our financial system. Of course, every shock is unique. But often, there are similarities. And often, there are differences with previous shocks. And it is up to us to distinguish between them. To draw on lessons learned for what is similar. And to look for new lessons for what is different. We have learned a lot from previous shocks. They allowed us to identify vulnerabilities in our financial system. And we have been able to strengthen our resilience and stability as a result. So far, no shock has been the Waterloo of our global financial system. But we need to remain vigilant. We need to remain diligent, in mapping, measuring and monitoring vulnerabilities. Old and new. So let's put the super trouper on the most recent episode of market turmoil, and take a closer look at what happened, what vulnerabilities were exposed, and what lessons we can learn from similarities and differences with the past. 1/5 BIS - Central bankers' speeches Roughly a month ago, on the other side of the Atlantic, Silicon Valley Bank failed. The reason for this was a classic bank run. Similar to bank runs in the past. Different in that this bank run was a direct consequence of SVB's specific business model. One that created a maturity mismatch: the interest rate on assets was fixed for longer than the interest rate on liabilities. On top of that, SVB made little use of interest rate derivatives to hedge this risk. The name of the game was serious risk mismanagement. However, this only became apparent once interest rates started rising. When this happened, SVB's interest expenditure rose faster than its interest income. As a result, net interest income fell and continued to fall. This was reinforced by the migration from non-interest bearing deposits – on current accounts – to interest bearing deposits – on the savings accounts and fixed-term deposits. When account holders got wind of the bank's weaker position, and the gimme, gimme, gimme- chant went viral on social media, a rapid outflow of savings followed. But due to the higher interest rates, the assets SVB had to sell to absorb this outflow of liquidity, mostly bonds, had lost value. Eventually, failure became inevitable. Most of you know this, of course. But why didn't we see it coming? The short answer is: money, money, money- it's so funny. The longer answer has to do with risk mismanagement. SVB's 2021 annual report shows that a 2 percent interest rate hike would have led to a 35.3 percent decrease in capital by the end of 2021. If the Basel interest rate risk standards had been in place, this would have set off a series of alarm bells. Because, according to these risk standards, this position should not exceed 15 percent of capital. And if it were to exceed 15 percent, the financial supervisor should intervene. But the Basel interest rate risk standards were not in place. So, it's not the case that the supervisor didn't hear the alarm bells. It's not that the alarm bells were quiet. It's that the alarm bells simply weren't ring, ring, ringing. So what can we learn from this? First and foremost – this case reaffirms that strong regulation makes for strong banks. The failure of SVB was a shock to the financial system. And shocks are, by nature, hard to predict. We can't change that. So we need to deal with it. And to deal with it, we need strong and consistent regulatory frameworks. Frameworks that strengthen capital ratios and risk management. Frameworks that mitigate the potential impact of vulnerabilities. We learned this from the Global Financial Crisis in 2008. And today, we can reaffirm the importance of the Basel Committee reform package. But there is a difference between designing the necessary tools to address vulnerabilities and implementing those tools. So, once again, I call for a quick and faithful implementation of the final Basel III standards, with minimal and restricted transitional arrangements or exceptions. This is needed in order to strengthen the stability of the global financial system. 2/5 BIS - Central bankers' speeches What else can we learn from the SVB failure? SVB was a relatively small bank in the US, working mainly with tech companies. But when it comes to buffers, the size of the institution is irrelevant. Every bank, whatever the size, whatever the scope, whatever the geographic location, should maintain strong buffers. Because a second lesson we have now learned, is that even a bank that was not considered to be a systemic bank, could still cause a lot of stress in the financial markets. Stress that could possibly have been avoided with sufficient buffers. Stress that, knowing me, knowing you, surely got us thinking about what we can do to improve our current policies further. And this brings me to my third reflection in the aftermath of SVB – or rather a few questions that might serve as food for thought. For starters, we need to make sure that our policies are up to date – and I mean that quite literally. Are our policies in sync with today's society? A society that, for a large part, is characterised by digitalisation and social media. A society in which, precisely because of this, liquidity risk seems to have become more acute. Indeed, it cannot be denied that the speed at which deposits were withdrawn from SVB was much faster than expected – much faster than LCR calculations take into account. And so, should LCR be calibrated differently? And/or do we need to better stress test it? Also - are there shortcomings in the way we look at interest rate risk? Should supervisors consider more frequently, and for each individual bank, whether additional Pillar 2 requirements are necessary, based on the bank's risk profile? And finally, should unrealised losses – that is the difference between market and book value for bonds which are held to maturity on banks' balance sheets – should those unrealised losses be better reflected in the capitalisation of banks? And should we look at how instruments, that are not marked to market daily, are reflected in liquidity buffers? I don't have an answer to these questions. But I do think they should be addressed. So that we can learn everything there is to learn from what happened at SVB. And of course, not only what happened at SVB. Because the problems at SVB soon led the financial market to look at other banks – banks with the same combination of vulnerabilities, like First Republic. These market concerns also found their way across the Atlantic, to this side, to Credit Suisse, a bank that has suffered from a series of mismanagement problems in recent years, and that experienced previous outflows of deposits at the end of 2022. Here, too, we witnessed a rapid succession of events. It took, almost literally, only one tweet to lead to the downfall of Credit Suisse. Because, once an alleged S.O.S. was on the wire, additional deposit outflows quickly followed, Credit Suisse's share price fell, and its CDS spread spiked. In the end, the Swiss National Bank provided additional liquidity assistance, and Credit Suisse was sold to UBS. 3/5 BIS - Central bankers' speeches FINMA, the Swiss supervisor, used a supervisory, and not a resolution power, to enable this sale – and it came with a write-down of Credit Suisse's AT1 securities. Although the possibility of such a principal write-down was included in the relevant AT1 prospectuses and mentioned on the bank's Investor Relations page, although investors were clearly informed that extraordinary public support could lead to such a write-down, and that AT1 holders may suffer losses before equity holders, and although the coupons paid on the AT1-security well exceeded the RoE-target Credit Suisse had communicated to its investors, FINMA's decision still took investors by surprise. This should encourage regulators to reflect on the role and functioning of AT1 instruments in determining the capital position of banks. But let's go back a step, and ask: why not use resolution? Or, with Alfred Nobel in mind, what similarities or differences with previous cases led to this strategy? In the aftermath of the Global Financial Crisis, resolution frameworks, based on the FSB's Key Attributes, were established. Just like cross-border cooperation between national regulators. The past has witnessed several cases where such a resolution framework has proven to be an effective safeguard for both depositors and financial stability. But at the same time, we haven't had many bank failures since the Attributes were published. Which, in a sense, makes every new case all the more different. And so, it makes it all the more important to draw lessons from this specific case. One lesson for sure is that it is essential to prepare more than one resolution strategy. Different circumstances require different strategies. So we need flexibility. This becomes all the more important in case of a liquidity crisis – when a bail-in can help to restore investor and depositor confidence by strengthening the solvency of the bank, but can't generate additional liquidity. What Credit Suisse has taught us, is that we need to further explore resolution strategies that are better able to stabilise a bank's liquidity position. Taking Alfred Nobel's advice, and observing and searching for differences and similarities, I can say that, today, we are in a very different situation compared to 2008. European banks have improved their capital positions and there is a structural change in the interest rate environment. And this is, in principle, good news for a bank's business model. The challenges of an artificially flat yield curve, negative interest rates, and fierce yield competition, have finally eased. But there are also similarities. Today, too, risks are lurking around the corner and there are numerous vulnerabilities. Risks related to funding costs and interest rate sensitivity, or credit-related risks. And vulnerabilities related to high levels of debt in many corners of our economy, or hidden leverage along with liquidity mismatches in the non-bank sector. 4/5 BIS - Central bankers' speeches This means that we need to remain vigilant. Supervisors, obviously. But also the banking sector itself – making sure their capital positions, risk management and governance strengthen their resilience in sentiment-driven markets. So, yesterday was the Dutch King's birthday. And if I am not mistaken, two days from now, on April 30th, His Majesty King Carl Gustaf will celebrate his birthday. I'm sure that in between there must be some room for a Dancing Queen. Congratulations in advance to all Swedes here today. Walpurgis Night is also celebrated in Sweden on April 30th. The night of the bonfire. A celebration of spring, new life and a brighter future. Well, if we keep learning from the past, from our experiences with shocks and challenges – if we, like Alfred Nobel said, keep searching for similarities and differences to expand our knowledge, then I am sure we are heading, indeed, towards a brighter future. Thank you. 5/5 BIS - Central bankers' speeches | netherlands bank | 2,023 | 5 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the International Banking Summit, Brussels, 1 June 2023. | Klaas Knot: To improve is to change Speech by Mr Klaas Knot, President of the Netherlands Bank, at the International Banking Summit, Brussels, 1 June 2023. *** "Many forms of financial systems have been tried, and will be tried in this world of sin and woe.No one pretends that the current financial system is perfect or all-wise. Indeed, it has been said that this system is the worst, except for all those other systems that have been tried from time to time-" Yes, this sounds familiar: it sounds like that famous Winston Churchill quote about democracy. But I am sure this is what he could have said – and would have said – had he been a banker- He would have been a formidable one. I can almost see him sitting there in the front row, puffing on a fat cigar. Grumbling about novelties like Bitcoin and TimeCoin. Reminding us again and again never to waste a crisis and never to give inIf he had said this about our financial system, he would have been right. Because I am convinced that our financial system, warts and all, is better than many alternatives. It has been tried and tested. By inflation and recession, by bank runs and financial crises, by innovation and incompetence. And we never gave in. Because we learned, we know, that as money makes the world go round, the system that regulates and oversees that movement cannot stand still, but has to stay in constant motion. It has to change with the times, adapting to new demands from the public and changing political tides. As Churchill really did say: "To improve is to change, to perfect is to change often." Our financial system has to be able to absorb change, to withstand shocks and address vulnerabilities. In other words: the global financial system has to be resilient. And to be resilient, financial institutions have to be well capitalised – because they too must be able to handle shocks. To achieve that resilience, financial regulators focus on vulnerabilities rather than on risks. We identify those vulnerabilities through rigorous monitoring, but they can also be exposed by certain events. Events of all shapes and sizes. Each event, each change, each shock gives us new insights – we learn lessons that help strengthen the stability of the financial system. To improve is to changeThe changes we implemented during and after the Global Financial Crisis of 2008 are a great example of this. We introduced a broad and comprehensive reform agenda, which led to the adoption of the Basel Committee standards. This agenda has proved its worth time and again, helping us navigate many challenging new events. But there is still plenty of room for improvement. The failure of Silicon Valley Bank two months ago, on the other side of the Atlantic, reminded us that we can never become complacent. It was a classic bank run. 1/5 BIS - Central bankers' speeches Similar to bank runs we have seen in the past. But it was also different, in that it was a direct consequence of SVB's specific business model. And it was highly concentrated, due to SVB's interest rate risk and strong reliance on uninsured deposits. The low interest rate on assets was locked in for a longer period than the one on liabilities. On top of that, SVB made little use of interest rate derivatives to hedge this risk. In short: the cause of the failure was serious risk mismanagement. SVB's 2021 annual report shows that a 2 percent interest rate hike would have led to a 35.3 percent decrease in capital by the end of 2021. If the Basel interest rate risk standards had been in place, this would have raised a number of red flags, causing the supervisor to intervene. But the Basel standards were not in place. Why not? Because the US did not implement these standards for smaller banks. Banks with less than 700 billion dollars in assets. In addition, between March '22 and February '23, the Fed raised interest rates by 4 point 5 percentage points, which is much more than the rate hikes that had been tested for. What can and must we learn from this event? One: the Basel III standards have to be fully and consistently implemented, with minimal transitional arrangements or exceptions. If not, banks may fail to adequately cover certain long-term risks with sufficient capital. Two: even the failure of a small non-systemic bank, a bank that we might not consider to be an internationally active bank, can lead to stress spilling over in global financial markets. Stress that causes unrest among customers, that eats away at the general public's trust in the financial sector – trust we have carefully tried to restore over the past decade and a half, and that no financial institution can do without. That is why we should reconsider the criteria for determining systemic importance with a fresh eye as to which banks the Basel III standards should apply. Three: social media and digitalisation are having an enormous impact on banking. One tweet can cause a bank run, and that bank run is most likely to be a digital one: the outflow of deposits at SVB happened much faster than expected, rendering the rates that are currently being used in Liquidity Coverage Ratio calculations obsolete. So it is time to reconsider the calibration of the LCR and our stress tests. Apart from these lessons, the failure of SVB also raises four questions. One: are there shortcomings in the way we handle interest rate risk? In Europe, the Basel standards for interest rate risk have been introduced under the institution-specific Pillar 2 requirements, and they apply to all banks. The recent turmoil underlines the importance of this regulation, as well as the need for continued vigilance. 2/5 BIS - Central bankers' speeches And that brings me to the second question: are our current assumptions about customer behaviour and deposit duration conservative enough in today's digital world? A third important question to ask is whether unrealised losses need to be better reflected in the capitalisation of banks. And finally, we should ask ourselves whether instruments that are not marked to market daily are adequately reflected in liquidity buffers. These are valid questions that I think should be addressed. Because events are opportunities to learn – to improve is to change. In this context, it is also important to consider recent events on this side of the Atlantic – namely what happened to Credit Suisse. What I would call an idiosyncratic incident. The result of a series of mismanaged problems in recent years, compounded by significant outflows of deposits at the end of 2022. Credit Suisse did not fail, but was sold to UBS. One interesting question to ask here is this: why did FINMA, the Swiss supervisor, use a market – and not a resolution solution – to enable this sale? We have come a long way in improving crisis preparedness in the banking sector. In the aftermath of the 2008 financial crisis, resolution frameworks were established. Frameworks based on the FSB's Key Attributes. At the same time, crossborder cooperation principles between national regulators were introduced. Of course, there have not been many bank failures since the Key Attributes were first published. Which, in a sense, makes every new case a rare and unique event. All the more important, then, to draw lessons from what happened to Credit Suisse. That is why the FSB has begun evaluating how the US and Swiss authorities responded to these recent events – to identify lessons learned and shed light on potential obstacles and areas for improvement. The FSB is currently assessing cross-border coordination mechanisms, which we view as a key factor in relation to crisis management. It is essential that these mechanisms are in place so that banks are resolvable not only on paper but also in practice. Another lesson we can learn from both SVB and Credit Suisse is that poor internal controls, risk culture and governance are at the root of other deficiencies in banks. Weak decision-making procedures and the absence of a healthy challenge culture hamper effective governance and strategic steering, which can ultimately lead to a bank failure. Events are opportunities to learn – to improve is to change. This means that we need to remain alert. This obviously goes for supervisors, but also for the banking sector itself. We not only have to keep learning from past events, but we must also think about what might happen in the future – about risks and vulnerabilities that are lurking just around the corner. Consider the rising interest rates, for example. While higher interest rates generally benefit financial institutions, the pace of the recent 3/5 BIS - Central bankers' speeches increases and the adjustments financial markets and institutions need to make as a result are cause for concern. After a period of abundant liquidity, these adjustments can amplify shocks to the system. The elevated debt positions that governments, companies and households have accumulated also constitute a major potential vulnerability. Corporate and government debt ratios in the euro area are currently 75 and 92 percent respectively. Government debt in particular saw rapid growth during the pandemic. In a low-interest environment, this additional debt would be easy to deal with. But with rising interest expenses, it could cause problems. This is particularly true for large debts that need to be rolled over and reinvested in the short term. These problems would affect our societies, our business communities and our economies, but they would also affect you – our banks and other financial institutions. After all, much of the debt that governments and corporations have accrued is owed to youRenewed volatility in the financial markets could also spell trouble. Investors have so far been very optimistic about inflation. The general expectation is that we will have returned to the target level of 2 percent by the end of next year. Financial markets are already pricing in interest rate cuts for next year. If they have to adjust this expectation, which is not unlikely, this could lead to new corrections. Of course, regulators and the financial sector are also grappling with structural shifts in the global financial system. Speaking as chair of the FSB, the priority areas we are looking at are the shift of financing activities from banks to the non-bank sector, the financial consequences of climate change, digitalisation and the rapid developments taking place in the crypto ecosystem. Events are opportunities to learn – to improve is to change. Again and again, these events – these developments – show that the financial system, our sector, is not a closed circle. And that it can never be one. Money makes the world go round, but it is the world that makes the money go round. Politics and social shifts, digital transformation and climate change, war and peace – they are all interconnected, and the financial sector plays a pivotal role in each. In a way, it is the heart of our world. And that heart has to beat an even rhythm. The good news is that European banks are stronger than they were in 2008. They have a more robust capital position and the rising interest rates we have seen lately are, in principle, beneficial to the banking sector's business model. 4/5 BIS - Central bankers' speeches Perhaps the main lesson to be learned from recent events is that money is not the only moveable feast. Regulation, supervision and banking should be seen as living things that have to go with the flow and move with the times. Our financial system must become more resilient and future-proof. And we must always keep in mind: events are opportunities to learn – to improve is to change. We do not need that imaginary man with the cigar in the front row, to remind us that in this world of sin and woe, we cannot stand still. So let's heed the advice Churchill gave to his War Office: "K-P-O" "Keep plodding on." 5/5 BIS - Central bankers' speeches | netherlands bank | 2,023 | 6 |
Keynote speech by Mr Klaas Knot, President of the Netherlands Bank, at the 5th Capital Markets Seminar, jointly organised by the European Stability Mechanism, the European Investment Bank and the European Commission, Luxembourg, 6 June 2023. | General news 06 June 2023 General “Bold, but realistic: monetary policy and financial stability” © DNB “Europe will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity. This bold, but realistic quote from Robert Schuman, one of the founders of the European Union, today, also guides monetary policy and financial stability.” In his keynote speech at the 5th Capital Markets Seminar, jointly organized by the European Stability Mechanism, the European Investment Bank and the European Commission, Klaas Knot discussed the current state of economic and financial affairs. Date: 6 June 2023 Speaker: Klaas Knot Location: The 5th Annual Capital Markets Seminar, Luxembourg City Good morning everyone. Today is June 6th. A date of tremendous historical importance. The day that, exactly 79 years ago, marked the beginning of the end of the Second World War. A day that you could see as the beginning of what we now know as the European Union. One of the founders of our Union was Robert Schuman. He was born just a stone’s throw from where we are today – right here, in Luxembourg City. What a bold man. A bold, but realistic man. “Europe,” he said, “will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity.” And indeed, looking back, there was no single plan. But what we do see, when we look back, are concrete achievements. Like our hosts today: the European Commission, the European Investment Bank, and the European Stability Mechanism. And what we also see, when we look back, is de facto solidarity. Between people, between countries, and in concrete achievements like Next Generation EU. The ESM is one of the youngest achievements in this very incomplete list. A mere 14 years ago, at the height of the euro crisis, we did not have the ESM. We did not have a European mechanism in place to deal with economic and financial stability issues. But many of you here today realised that we needed one. And it is testament to you, and all those involved, that the ESM has become, in a very short time, a cornerstone institution of the European Monetary Union. During the sovereign debt crisis, it was directly involved in successfully restoring market access to multiple euro area member states. One quick look at today’s relative borrowing costs tells a very convincing story here. Today, the sovereign debt crisis seems like something from the distant past. It was followed by a pandemic and, soon thereafter, Russia’s brutal and unjustified war on European soil. This triggered an energy crisis that many European households and businesses still suffer from, along with the revival of persistently high inflation. As central bankers, we did not foresee all of this. It was not part of the plan. But we are dealing with it. Because like Schuman’s Europe, monetary policy and a stable financial system will not be made according to a single plan either. They will be made step by step. One concrete achievement after the other. Until not so long ago, euro area inflation was persistently below our target of two percent over the medium term. And although short-term interest rates were near the effective lower bound, inflation was not budging. This led the ECB, and many other central banks, to deploy a range of “unconventional” tools such as (Targeted) Long Term Refinancing Operations and large scale asset purchases. And when the pandemic hit us, the pace and volume of purchases picked up substantially. Of course, unconventional monetary policy instruments are not without risk. When central banks increase their footprint in financial markets, the allocation of resources in the economy will be distorted. And, by substantially lowering both short-term and longer-term interest rates, vulnerabilities in the financial sector and real economy will increase. To be frank, policymakers were facing a trade-off then, between medium-term inflation considerations and longer-term financial stability concerns. You can see how monetary policy advanced step by step on the next slide. Once the pandemic-related measures gradually eased, demand recovered faster than many, including myself, had anticipated. Combined with some lagging distortions in international supply chains, this led to rising inflation. And then Russia invaded Ukraine. On February 24th, 2022. An act that will go down in history like June 6th, 1944, but for very different - in fact entirely opposite - reasons. More like September 1st, 1939. An act as unjustified as unforgiving. Russia’s attack had an immediate effect on Europe’s energy supply. And it caused record high and surprisingly persistent inflation in the euro area. As a consequence, monetary policy needed to be tightened – quickly and decisively. So that is what we did. We phased out our asset purchases and raised interest rates in an unprecedented fashion. And this paid off. At its peak, headline inflation was 10.6 percent. Now, it has come down to just above 6 percent. Clearly this is still way too high. But I do believe that, in the absence of further supply shocks, the worst is behind us in terms of the immediate assault on our citizens’ purchasing power. However, a strong word of caution is still in order. Because inflation was high for a long period, underlying inflationary pressures have built up. As a consequence, we now observe second-round effects – energy prices have found their way into other items in the consumer basket, and wages and services in particular have taken over the inflation torch. It is likely that price pressures in these areas will prove more difficult to bring down. It has clearly been a decade of extremes for monetary policy. But despite all of this, inflation expectations are still decently anchored, and let us hope that the next decade will not be so eventful. What we do in the realm of monetary policy, is, of course, aimed at having an effect on the real economy and then onto inflation. We know that this transmission always comes with a lag, whether monetary policy is easing or tightening. But in the spirit of Robert Schuman, we do aim for concrete results. So it is reassuring to see the first signs of recent monetary policy actually being transmitted to the real economy. On European capital markets, financial conditions have tightened. And euro area banks are reporting tighter lending standards. If you look at this graph, with the composite borrowing costs of both non-financial corporations and households on the left, and credit growth on the right, you can also see that interest rates for households and firms have increased faster than in previous episodes with rising interest rates. This development is in line with the steeper policy rate path compared to previous tightening cycles. We also see these higher rates reflected in lower credit growth in the euro area. The effect of monetary tightening can also be observed through macro-financial indicators. For example, over the past decade, euro area housing prices skyrocketed. In the Netherlands they almost doubled. Now with the shift in monetary policy, we are observing the first persistent decline in a long time - the number of transactions is going down and the number of houses being sold above the asking price is sharply decreasing. These are only the first, concrete steps in the transmission of our monetary policy tightening. And we have yet to see their full effect. So the current situation is one in which our monetary policy is killing two birds with one stone: it is addressing medium-term risks to price stability, while the direction of monetary policy - in principle - aids in addressing longer-term financial stability concerns. You would think this is a comfortable position for policy makers. Nonetheless – a word of caution is in order here too. While medium-term inflation and longer-term financial stability policies are now more aligned, a short-term financial stability risk looms around the corner. An abrupt change in monetary policy requires a massive adjustment in the financial system, which could also trigger some of the vulnerabilities that have accumulated in the past. As we know from theory, higher interest rates can be beneficial for financial institutions. They underpin their profitability and solvability. But do we also see this practice? I have borrowed this graph from the ECB’s most recent Financial Stability Review. The panel on the right depicts the annual changes in operating profits and their drivers. The dark blue part shows that in 2022 the operating profit of European banks ballooned due to net interest income. This can be attributed to the relatively sluggish interest rates on saving deposits. It is expected that such passthrough will increase further this year. But moving from theory to practice, things have a tendency to become a bit more unruly. Testimony to this is the recent banking turmoil in the United States, where sharp increases in interest rates were inadequately accounted for. And this ultimately led to a series of bank failures. Against the backdrop of much tighter management and supervision of this so-called interest rate risk in the banking book on this side of the Atlantic, similar banking failures have not manifested itself in the euro area. At the same time, I regard debt sustainability, in the broad sense, as one of the major financial stability risks on either side of the Atlantic. And rising interest rates have brought this vulnerability to the surface. There is no linear correlation between the two – here at the ESM I do not have to belabour the point made by Dornbusch and others that markets can regard debts as sustainable for quite some period of time, before they no longer do. Such potential non-linearities call for additional caution. Households are experiencing a real income squeeze, which compromises their debt servicing capacity. Though some can benefit from having fixed their borrowing costs at extended maturities during the low-for-long era, this only partially and temporarily cushions the blow. And non-financial corporates face a similar situation. In the Netherlands, for example, 38 percent of total debt of non-financial corporates will mature within the year or will have to be refinanced at a likely higher interest rate. Higher interest expenditures might eventually also trigger some corporate liquidity issues. And alongside households and non-financial corporates, the debt sustainability of euro area sovereigns is also affected by the recent rise in bond yields. Here too, the low-for-long era has partially been locked-in with fixed borrowing rates spanning a relatively long horizon. But this can only buy time rather than obviate the inevitable adjustment in the primary fiscal balance. So I urge caution. Even though our financial system has proven its resilience, largely due to the buffers we have built since previous crises, and even though we have weathered the shocks of recent years, we mustn’t be complacent. Building resilience does not prevent shocks from happening. It just helps us to deal with them. So it is encouraging that we as central bankers, in deciding on our course of action, have started to pay more attention to the interplay between monetary policy and financial stability. Monetary policy affects the stability of the financial system. But in turn, we need a stable financial system to effectively transmit monetary policy. Financial stability is a pre-requisite for medium-term price stability. And as Chair of the Financial Stability Board, I must underscore that a stable financial system is also a goal to be pursued in its own right. So where does that leave us? Central bankers will have to continue tightening monetary policy for as long as necessary, until we see inflation return to our two percent target over the medium term. But we will do this step by step. Because the tighter monetary policy gets, the more forceful its transmission to output and prices that is still largely in the pipeline. And with each step, the financial system will have to continue adjusting to the higher interest rate environment. The recent financial turmoil on the other side of the Atlantic illustrates that this cannot be taken for granted. And with each step, we continuously learn from our experiences. Allow me to share with you two valuable lessons we have learned in recent years. Lessons that will help us walk this tight rope – step by step. Lessons that will help us tackle future challenges – and go from one concrete achievement to the next. A first lesson from the recent episode is that the so-called separation principle can be maintained for longer than some might have expected. According to this principle, a central bank should clearly separate its function as lender of last resort from its function as monetary policy maker. Since the Global Financial Crisis, policy makers worldwide have become more experienced and more innovative with various forms of lending operations. With this experience came a more coherent and powerful toolkit. A toolkit that can, and in my view should, be used to adhere to the separation principle for as long as possible. Against the backdrop of a better regulated and better capitalised financial system, we can now deal with a broad range of financial stability related risks without compromising on medium-term price stability. The second lesson we have learned, is that moderate and contained levels of financial turbulence do not necessarily have to be at odds with medium-term price stability. Repricing of risk in financial markets can contribute to tighter financial conditions for a given policy rate. Monetary policy normalisation also entails a reduction of the central bank footprint in financial markets, a decompression of term premia, and some repricing of risks. As long as such repricing is not excessive, it can in fact be combined with a somewhat lower terminal policy rate that would still be compatible with medium-term price stability. “Europe will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity.” Bold, but realistic. Bold because it set out an ideal. An idea. A vision for Europe. Realistic because achieving this would not happen overnight. It would happen every time a step forward was taken. It would happen every time a concrete result was achieved. It would happen through setbacks, shocks and surprises that were overcome and learned from. Over the past years, monetary and macroprudential policy makers have achieved very concrete results. Often to be confronted with new challenges soon after, not least because monetary and macroprudential policy are intertwined. And these challenges once again called for policy innovation. And maybe that is the essence of Schuman’s vision: that the idea, the ideal of Europe was not set as a goal-to-achieve, but as a guide, to help us along the way. Step by step. One concrete achievement after another. Improvising as we go along, but always in the same direction – towards an integrated, solidary and peaceful Europe. The kind of Europe we will need in order to tackle our future challenges. Thank you. | netherlands bank | 2,023 | 6 |
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the General Assembly dinner of the European Association of Co-operative Banks (EACB), Brussels, 8 June 2023. | Steven Maijoor: Keeping our windshiels intact - lessons from the recent market turmoil Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the General Assembly dinner of the European Association of Co-operative Banks (EACB), Brussels, 8 June 2023. *** Good evening everyone, Thank you for having me here. I have always known the EACB to be a constructive player, offering helpful contributions in the field of social responsibility and giving useful and constructive input on draft EU financial regulations. So I am happy to speak here today at this General Assembly dinner. In the US, there's an old saying: whenever the Fed hits the brakes, somebody goes through the windshield. Well, the Fed has hit the brakes again. And so have the ECB and other central banks. They've hit the brakes pretty hard. Because that's what central banks do when inflation reaches levels not seen in forty years. And sure enough, we have seen some windshields shatter recently, on both sides of the Atlantic. Let me share with you my take on the past few months, focusing on what happened at Silicon Valley Bank and Credit Suisse, the lessons we can draw from these events, and what this means for the European banking landscape. If somebody hits the windshield, the first obvious question to ask is: were the seatbelts securely fastened? SVB clearly wasn't buckled up. This was a case of serious risk mismanagement. SVBs interest rate mismatch, whereby the interest rate on assets was fixed for longer than the interest rate on liabilities, was not hedged with derivatives and was inappropriately managed. When interest rates started rising, SVB's interest expenditure grew faster than its interest income. As a result, net interest income started falling. And it kept falling. This was reinforced by the migration from non-interest bearing deposits – on current accounts – to interest bearing deposits – on savings accounts and fixed-term deposits. When account holders got wind of the bank's weakened position, there was a rapid outflow of savings. And due to the higher interest rates, the assets SVB then had to sell to absorb this outflow of liquidity, mostly bonds, had lost value. No airbags, no seatbelts, and there went the first windshield. Of course, most of you already know all of this. But why did no one see it coming? SVB's 2021 annual report shows that a 2 percent interest rate hike would have led to a 35.3 percent decrease in capital by the end of 2021. If the Basel interest rate risk standards had been in place, this would have set off a series of dashboard warning lights flashing red. Because, according to these risk standards, this position should not 1/4 BIS - Central bankers' speeches exceed 15 percent of capital. And if it were to exceed 15 percent, the financial supervisor should intervene. But the Basel interest rate risk standards were not in place. So, the supervisor was not forced to intervene. So what can we learn from this? First and foremost – what happened at SVB reaffirms the need for strong regulations. Regulations that strengthen capital buffers and risk management. Because these are the airbags and safety belts of our financial system. So it will not surprise you that I am even more convinced that we need a quick and faithful implementation of the final Basel III standards, with minimal and restricted transitional arrangements or exceptions. In Europe, we have implemented the Basel standards more consistently across banks of all sizes. But let's not forget that the Basel III standards have not yet been fully implemented in European regulation. And in fact, current proposals to do so contain important deviations and transitional arrangements. Arrangements that, if adopted, could lead to inadequate capital coverage of some risks for a long time. The recent stress reminds us that this is something we should really think twice about. What happened at SVB also underlines the need for strong, assertive supervisors. One thing the Fed's evaluation of the SVB case makes clear is how important it is that supervisors not only understand the risks and vulnerabilities of the entities they supervise, but that they also make full use of the instruments in their toolboxes. Only then can they be effective and ensure that banks fix their problems. A second lesson we have learned from the SVB failure is that even a relatively small bank, that was not highly connected to other banks, can still cause contagion and spread a lot of stress in the financial system. Stress that could possibly have been avoided with sufficient buffers and a further strengthening of current policies. And this brings me to my third point about SVB – or rather a few questions that might serve as food for thought. For starters, liquidity risk seems to have increased, partly as a result of social media and digitalisation. The speed at which deposits were withdrawn from SVB was much faster than expected – much faster than LCR calculations take into account. Which raises the question: should the LCR be calibrated differently? Should we assume higher outflow rates? And do we need to improve our stress tests? We might also ask ourselves if there are shortcomings in the way we look at interest rate risk and the mismatches banks have on their balance sheets. In Europe, the Basel standards for interest rate risk have been introduced through the institution-specific Pillar 2 requirements, and they apply to all banks. The recent turmoil underlines the importance of this regulation, as well as the need for continued vigilance. Are we sure that the underlying assumptions for customer behaviour and deposit duration are conservative enough in today's digital world? Banks should monitor very closely the assumptions they make when managing interest rate risk and adjust those assumptions if there is reason to do so. 2/4 BIS - Central bankers' speeches And finally, should unrealized losses – that is the difference between market value and the valuation based on historical cost – should those unrealized losses be better reflected in the capitalization of banks? And should we look at how instruments that are not marked to market daily are reflected in liquidity buffers? It would be for example useful to tighten the use of these assets as high-quality liquid assets. These are all valid questions that I think should be addressed. So that we can learn everything there is to learn from what happened at SVB. Let me now turn to this side of the Atlantic, where we had our own shattered windshield. Shattered by Credit Suisse, a bank that had suffered from a series of mismanagement problems in recent years, and that experienced previous outflows of deposits at the end of 2022. Here, too, we witnessed a rapid succession of events. It took, almost literally, only one tweet to lead to the downfall of Credit Suisse. Deposit outflows quickly followed, the share price fell and the CDS spread spiked. In the end, the Swiss National Bank provided additional liquidity assistance, and Credit Suisse was sold to UBS. FINMA, the Swiss supervisor, came with a write-down of Credit Suisse's AT1 securities. The bank was not bailed out. Instead capital providers contributed significantly to its restart, exactly as intended by the new legislation after the global financial crisis. At the same time, things did not go as smoothly as we had hoped. The decision by FINMA took investors by surprise. Despite the fact that the possibility of such a principal writedown had been included in the relevant AT1 prospectuses and mentioned on the bank's Investor Relations page. And despite the fact that investors had been informed that extraordinary public support could lead to such a write-down. To me, this shows that we need to reflect on the role and functioning of AT1 instruments in determining the capital position of banks. Another lesson we can learn from both SVB and Credit Suisse is that internal controls, risk culture and governance are root causes that may bring up other deficiencies in a bank in a later stage. If there are several passengers pulling at the wheel as the car is about to drive off a cliff, airbags and seatbelts aren't going to help you. So banks need to be aware of their decision-making procedures and promote a healthy company culture in order not to hamper effective governance and strategic steering. That's why I firmly support that risk culture and governance are priorities in the banking supervision by the SSM. Looking at everything that has changed in the European banking sector since 2008, I think we are in a different situation now. European banks have stronger capital positions and the change in interest rate environment is in principle good news for the banks business models. Also, European supervisors are well aware that the ongoing, fast-paced changes in monetary policy conditions are increasing our banks' exposure to interest rate risk. Within the SSM, we therefore started assessing interest rate risk as early as the second half of 2021, when the first signs of inflationary pressure emerged. And in 2022, interest rate risk was included in our supervisory priorities. So these are all positives. 3/4 BIS - Central bankers' speeches But there is absolutely no reason for complacency. Interest rates are still rising, and this leads to risks related to funding costs and interest rate sensitivity, or credit-related risks. And the high level of debt and interconnectedness in the system creates vulnerabilities, as well as a large number of unknown unknowns. Not to mention the long-term structural challenges we face, like climate change, the transition to a sustainable economy and the ongoing digital transformation. This means that we need to remain vigilant. In the first place, this goes for the banking sector itself, which needs to make sure that its capital positions, risk management and governance strengthen its resilience in a very uncertain and volatile environment. But supervisors must also remain vigilant. As central banks hit the brakes, financial stability risks inevitably increase. But if we make sure our airbags, seatbelts and warning lights all work, we can hopefully keep our windshields intact. 4/4 BIS - Central bankers' speeches | netherlands bank | 2,023 | 6 |
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Netherlands Bank Seminar "Supervision of Payment Institutions", Amsterdam, 14 April 2023. | Steven Maijoor: Paying attention – on the supervision of payment institutions Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Netherlands Bank Seminar "Supervision of Payment Institutions", Amsterdam, 14 April 2023. *** Hello everyone. Out of curiosity and because I knew I would be talking to you today, I checked my banking app to see how many times I recently used one of your services. And even though I work for De Nederlandsche Bank, even though I am a supervisor and I know your sector well, I was still amazed at how often I saw one of your names appear. I saw one of you when I bought some sailing gear. I saw one of you when I ordered tickets for the St. Matthew Passion. And I saw one of you when I donated to a charity. There are already 81 licenced payment institutions in the Netherlands. And all 81 of you help businesses thrive. All 81 of you help people, like me. Online, when we scroll, select and then securely pay. Or offline, when we pay at one of your pin terminals or with a QR code. Or when we check our bank account, after everything is paid for, to get an insight into our spending patterns. All this means you have become a cornerstone of our financial system. And all this means you have become part of the financial supervision of De Nederlandsche Bank. Formally, our supervision of your industry is rooted in the Payment Services Directive from 2009, PSD1, and the update, PSD2, from 2019. It is also rooted in the Anti-Money Laundering and Anti-Terrorist Financing Act from 2008. Theoretically, one could say that supervising the trustworthiness of our financial system is about finding the right balance between entrepreneurial opportunities and stability risks. Practically, supervision has to do with mapping, measuring and monitoring the risks to which you, and with you the entire financial system, are exposed. Let me illustrate this – with a credit risk example, and a cyber risk example, but first with an example related to integrity risk. 1/5 BIS - Central bankers' speeches An estimated 16 billion euros a year – that is how much criminal money is earned in the Netherlands. Half of this amount finds its way abroad. And from abroad, another 5 billion will find its way back to the Netherlands. Often that dirty money is looking for a way to get clean. And when it does, it's not a good thing. Because it undermines trust – trust in our rule of law, in the security of our society, and in the integrity of our financial system. In addition to banks, more and more people and businesses are relying on you for payment transactions. And it's your job – at least in part – to accept only clean money. To refuse dirty money. To guard the gate to the financial system, and in doing so, to keep it clean. Or at least, clean-ER. Of course, there are many gates to the financial system – and you only have to guard yours. But criminal money will try every gate – so we depend on each other to keep the system we work in, the system we work on, to keep that system as clean as possible. Next to this type of integrity risk, another type of integrity risk has received a lot of attention recently. And that is sanction risk. After Russia invaded Ukraine, an act of aggression that is, by any measure, unjustified – the European Commission introduced a whole package of sanctions. And those sanctions are partly designed to prevent certain transactions to and from Russians on the sanctions list. And also in this case, you have a vital role to play. At De Nederlandsche Bank, we are very aware of the investments your industry has already made to guard your gate. Regarding anti-money laundering. Regarding antiterrorist financing. And regarding sanction risk. But unfortunately, we also know that some in your sector are still lagging behind. That in too many cases, basic housekeeping to mitigate these important risks is still insufficiently organised. To those of you to whom this applies, I say: we expect more from you. And let me add that you can also expect something from us, your supervisor. And that is our commitment to focus our supervision on where risks can actually materialise. And that we can have a conversation about this. Let me illustrate this. Your sector raised a concern to DNB regarding the obligation to screen all transactions from all shoppers. While I do not want to go into legal and technical details, I do want to emphasize that we take your feedback seriously. Of course, I understand that when I buy a book on sailing online, and my payment goes through one of your institutions, it has little value added for us if we require you to check whether or not I am on the sanction list. 2/5 BIS - Central bankers' speeches When you see that I have a Dutch banking account, it is highly likely that I was already screened against Dutch sanctions lists by my issuer institution. And when I am buying something from an online bookstore, I am very likely paying for a book. So, in this case, what actual sanction risk would there be, right? Well, you know just as much as I, that, in reality, things are often not that straightforward. Suppose you are less convinced that I am buying a book. Suppose I could be buying image intensifier tubes, a so-called dual use good. And suppose I do not use a Dutch banking account to pay for it, but a foreign one. Supposing all that, could the benefit of screening on your end get the upper hand? I am merely asking the question. I don't have an answer. But what I do have, is three things you can expect from us. Going forward, we will bring your concerns to the attention of the Ministry of Finance and share insights from our supervision. This ensures that your concerns are taken into account in the upcoming update of the sanction regulation. We will also discuss this at the European level – to improve the level playing field in Europe. Third, and at this moment probably most important for you, we are aware of the fact that institutions do not screen each domestic shopper payment. But in the meantime, we won't spend scarce supervisory resources on this. We have other priorities. But I will, of course, insist that you know where your higher risks lie, and that you mitigate these accordingly. And in that respect, there is still enough work to do for the sector, for example when it comes to improving the detection of transactions related to dual use goods. Let me now turn to my second example. This has to do with cyber risks – a kind of risk that, over the past years, has increased significantly, and with the war in Ukraine even further. Also for you. We know that in the past some of you have already had to actively – and successfully – defend your institution from cyber threats. It is, of course, no wonder that cyber threats are on the rise. Looking at the broader financial sector, we have seen that, over the years, financial institutions have been morphing more and more into IT companies with a financial licence. More and more of what financial institutions do, takes place digitally. As a consequence, the IT infrastructure has become more and more essential to the functioning of financial institutions as a whole. 3/5 BIS - Central bankers' speeches Looking at the payments industry, you are the prime example of this broader evolution. And your digital infrastructure forms the very core of your operations. It is no wonder then, that you are well aware of cyber threats, and as a consequence, that you have robust defences in place against attacks like DDoS. But cyber threats are growing in number and variety – so we must remain vigilant. That is why I am worried about what we found in our sectoral review of IT risks. We found that payment institutions still only make limited use of existing cyber security frameworks. Or of sectoral security intelligence and information sharing groups such as ISAC and CERT. Because even though there is a dedicated ISAC for payment institutions, we found that most of you are not participating in it. Why is that? From our experience with other sectors, we know that external resources, such as information sharing groups, can be beneficial. We know that by exchanging cyber intelligence amongst peers, you can increase your cyber resilience. So why doesn't this happen more? My aim as supervisor is to safeguard trust in the financial system – a system of which you are a cornerstone. And that is why cyber threats, no matter how they appear, are high on my agenda – and that is also why they should remain high on yours. My third and final example has to do with credit risk. On March 10th, Silicon Valley Bank went bankrupt – as you all know. Silicon Valley Bank was one of the go-to banks for fintech businesses on the other side of the Atlantic. If you were not mainly operating here on our side of the Atlantic, you might have worked with Silicon Valley Bank – for instance to deposit your clients' funds. But also on our side of the Atlantic, payment institutions use third parties to deposit their clients' funds for safekeeping. And here lies a risk, or at least a responsibility. The responsibility to monitor the creditworthiness of that third party. Unfortunately, we know from our thematic examination on safeguarding that a number of payment institutions do so insufficiently. What's more – when drafting risk analyses, some payment institutions pay too little attention to the operational and financial risks of the third parties they rely on. It goes without saying that what happened to Silicon Valley Bank was the result of poor risk management. And what happened, seriously damaged trust in the financial system. You don't want that. And we don't want that. So that is why an important part of our supervision focuses on the way you work with third parties. On the way you monitor and mitigate the risks that come with working with third parties – be it a cloud service 4/5 BIS - Central bankers' speeches provider or an IT vendor. But our supervision also focuses on the way you manage financial exposures. And certainly on how you select banks to deposit your customers' funds. When I looked at my bank statements, I was amazed by how much I rely on you, payment institutions. And along with me, many others in the Netherlands do so too. The thriving payments industry in our country is reflected in the enthusiastic use of your services by tons of Dutch businesses and organisations. You can be proud of that – of being at the forefront of our digital society. But with that success comes great responsibility. People rely on your services. Businesses depend on you. But many risks – and I only touched on integrity risks, cyber risks and credit risks – but many risks loom around the corner. In order for people and businesses to continue to rely on you, those risks need to be dealt with. They need to be mapped and measured, monitored and mitigated. And they definitely need to be a topic of conversation. That is why I am grateful to see so many of you here today. So that we can share stories and worries. Questions and concerns. Expectations met- and expectations unmet. In short, the better we understand each other, the better we can keep our financial system as clean and secure as possible. I wish you all a frank and fruitful afternoon. Thank you. 5/5 BIS - Central bankers' speeches | netherlands bank | 2,023 | 6 |
Speech by Mr Olaf Sleijpen, Executive Board Member of Monetary Affairs and Financial Stability of the Netherlands Bank, at the EU banking industry: a guide on sustainable finance – ESG, Madrid, 28 June 2023. | Olaf Sleijpen: High hopes - rooting the CMU in sustainable finance Speech by Mr Olaf Sleijpen, Executive Board Member of Monetary Affairs and Financial Stability of the Netherlands Bank, at the EU banking industry: a guide on sustainable finance – ESG, Madrid, 28 June 2023. *** Hello everyone. In 1946, Europe lay in ruins. The Second World War had ended, but it had left deep wounds in our cities, our communities, and in the very core of what makes us human: hope. But, like Emily Dickinson wrote: Hope- is the thing with feathers. And so, soon after those horrible years, people looked to the future. With hope. Among them, the founders of the European League for Economic Cooperation. To them, it was clear: to prevent war from ever raging again on this continent, we needed European integration. Today, this still rings true. Unfortunately, however, the old threat of war has become reality again. And also new threats have emerged. Global warming, and the degradation of the natural world we live in, have put our backs against the wall. But, hope is the thing with feathers. In April last year, the governments of Spain and the Netherlands reflected, together, on the priorities for the EU's economic and financial policy. In a joint paper, they emphasized the importance of a strong European Union. By finding consensus, they underscored the motto of that joint paper: "collectively, we achieve more than individually." Currently, the European economy has a large dependency on the banking system. But this banking-bias makes us vulnerable. It increases systemic risk, and as a result, it decreases our resilience to financial shocks. Unfortunately, we don't have much of an alternative today. However, we need not look far for one. Because what we need, is a well-developed and integrated capital markets union. Spain and the Netherlands agree on this. They agree that it is important to have one single market for capital across the EU. One single market in which investments and savings can flow freely. One single market to benefit consumers, investors and companies, regardless of where they are located. Because the more financial risks are shared privately, the more systemic risk decreases, and the more our resilience to shocks increases. Today, those shocks also come in the form of floods, droughts and heatwaves. In the form of pollution, overexploitation, and animal and plant extinction. In the form of disasters that threaten lives and livelihoods. Nature and climate have gone rogue – in Spain and in the Netherlands, in Europe and in the rest of the world. But- hope is the thing with feathers. 1/3 BIS - Central bankers' speeches To turn the tide, Europe needs the green transition. Sooner rather than later. But, of course, that costs money. The European Commission estimates that a yearly additional investment of 350 billion euros is needed to meet the 2030 emissions-reduction target in energy systems. Another estimated 130 billion euros is needed for other environmental goals(Refers to an external site). In total, we are talking about 480 billion euros a year. Both in terms of type of investment as in the sheer number, this is simply too much for the public sector alone. We need private investment. Like equity financing. Because more than debt financing, it is equity financing that will increase investments in green and innovative projects. Because of the greater riskappetite of equity investors and their longer term investment horizon(Refers to an external site). Currently, however, European SMEs are heavily reliant on own funds and bank loans for their green and innovative projects. In the US, for example, they would be able to turn to venture capital. But that kind of market for risky investments doesn't exist here – at least not to the same degree(Refers to an external site). As a result, successful, green, innovative companies lack funding for substantial growth. Enter – indeed – a capital markets union. This would allow for a proper allocation of the necessary private investment for the green transition(Refers to an external site). It would sustain investment flows. And it would strengthen our resilience to nature- and climate-related shocks. And this also works the other way around. Today, sustainable finance products account for a small share of the euro area capital markets. But that share is growing. And that offers a leverage to foster a European Capital Markets Union. Because, compared to the aggregate bond market, the green bond market has a lower home bias. It shows a higher degree of integration. And euro area green bonds are held cross-border twice as likely as other bonds. Green investment funds also have a more stable and committed investor base. And so, if green capital markets were to deepen further, sustainable finance could help advance financial integration in the European Union. And remove the legal impediments for developing a CMU. Of course, we need to ensure that the fragmentation in underlying capital market structures and the lack of green bond standards does not change these positive developments. But this just adds to our plea for rooting the CMU in sustainable finance. In 2020, the European Commission adopted a new CMU Action Plan. Hopes were high then. But till this day, not much has become of it. Things are advancing too slowly. And the closer we get to next year's European elections, the bigger the chance that divisive initiatives, like a capital markets union, end up in a drawer entirely. 2/3 BIS - Central bankers' speeches Of course, central banks don't have a seat at the legislative table. But it is our obligation to be vocal about what is at stake. To be vocal about the lack of progress and ambition. Let me mention three areas in which, I believe, progress is insufficient. First of all, there are still significant gains to be made in the area of availability and comparability of market and business information. To this end, it is particularly important that the European Single Access Point is properly implemented, and that negotiators reach an ambitious agreement on consolidated tape. Second, not enough progress has yet been made on uniformity in supervision and application of macroprudential and other rules. Going forward, we need to search for ways in which ESMA can play a more central role as a market regulator to converge standards. Market participants still have to deal with 27 different national regulators, which contributes to regulatory uncertainty and information asymmetry. And third, we need further harmonisation of laws and regulations. The Commission's proposals on withholding tax and insolvency are good first steps. But agreements remain uncertain. Even if the current agreements materialise, there is still much more potential here to remove key transaction costs that currently discourage cross-border investment. The prospect for the future could be a common insolvency framework, taking inspiration from the Bank Recovery and Resolution Directive. So, I see clear areas for progress, and we mustn't stop advocating for a CMU that is rooted in sustainable finance. Because only then will our financial system be able to face the increasingly severe consequences of global warming, and of phenomena like El Niño, and La Niña. But let us also be like the founders of the European League for Economic Cooperation. Let's look ahead, to the future, and let's do that with hope- the thing with feathers. Thank you. 3/3 BIS - Central bankers' speeches | netherlands bank | 2,023 | 7 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Flairs conference, Amsterdam, 29 September 2023. | Klaas Knot: Banks going bankrupt Speech by Mr Klaas Knot, President of the Netherlands Bank, at the Flairs conference, Amsterdam, 29 September 2023. *** Thank you. And what an uplifting topic you have asked me to talk about! As president of an organisation that is responsible for banking supervision, having to talk about banks going bankrupt feels a bit like giving a speech about your most spectacular failures. But the sober fact is that we can never rule out the possibility of banks going bankrupt. In fact, the very words bank and bankruptcy are closely related. The word bankruptcy is derived from the Italian 'banca rotta', literally meaning 'broken bank'. The story goes that in Renaissance Italy there was a tradition of smashing a banker's bench if he defaulted on payment. So that the public could see that the banker, the owner of the bench, was no longer in a position to continue his business. Despite strong buffers, despite supervision, banks can go bankrupt. That's all part of a healthy, dynamic, competitive banking sector. And in fact, at the current juncture, with interest rates having gone up – while justified to keep inflation in check – the risk of accidents is increasing. As the Americans say 'Whenever the Fed hits the brakes, someone goes through the windshield.' The problem is of course that a bank failure may threaten financial stability. Because of contagion, because banks are interconnected, and because of the vital role banks play in the economy. So one of the lessons from the Global Financial Crisis is that we – that is central banks, supervisors and the banks themselves – should be thoroughly prepared for a failure, if one happens. So that the bank can be laid to rest in an orderly way, and essential public functions can continue. To illustrate what happens when you are insufficiently prepared, let me tell you one or two stories about Fortis, the former Belgian-Dutch financial conglomerate. In September and October 2008, I participated, as senior aide to the previous Governor, in the crisis management meetings in Brussels to prevent the imminent collapse of Fortis. At the time, we still had to rely on general bankruptcy laws and insolvency liquidation that were completely unsuitable for financial institutions. Particularly for those institutions that provide critical economic functions. Functions that need to be maintained. So we had to improvise a lot. For example, we did not have the legal instruments to impose losses on shareholders while keeping the conglomerate running. The existing framework for information sharing and policy coordination between the home and host supervisors was flawed, to put it mildly. And there was no pre-arranged plan for funding in case of resolution. I remember that once the agreement was struck about nationalisation of the Dutch parts of Fortis, the Dutch State Treasury had to go to the market to raise 50 billion euro practically overnight. A large part of this was needed to secure funding for Fortis Bank Netherlands. 50 billion, that was almost one fifth of our pre-crisis national debt. On top of that we had to provide massive emergency liquidity assistance. I could go on and on. It could easily have become our European Lehmanmoment. 1/4 BIS - Central bankers' speeches Prior to 2008, we had never thought about these things in a thorough and consistent way. As a result, we had to take a lot of ad hoc measures during the Global Financial Crisis. These measures were successful in the short term, in the sense that we were able to prevent an even bigger disaster. But in the long term the societal cost was high. The use of taxpayers' money to support banks was not well received by society and it created perverse incentives. Private gains, public losses. For a solid banking system there needs to be a credible threat that banks, like any other company, can go out of business if they take on too much risk. That credible threat can only exist if there is a reliable system for putting troubled banks out of business without triggering a financial Armageddon. So, after the Global Financial Crisis governments, central banks and supervisors, under the leadership of the G20 and the Financial Stability Board, improved their tools for making banks more resilient. By mitigating risks and building buffers. And for those cases where these first and second lines of defence are not sufficient, we also built a third line of defence, the resolution framework: legislation, instruments, authorities, planning requirements for both authorities and banks, in order to make sure that a bank failure does not destabilise the financial system and threaten basic public functions such as saving and paying. Over the past 12 years, a whole resolution infrastructure has developed. This goes for the banking sector, but also for insurers and CCPs, albeit at a less advanced level in most jurisdictions. In many countries today, designated resolution authorities are in place that possess the necessary legal powers and operational capacity to intervene in, and resolve, financial institutions that are no longer viable. For internationally active firms, crisis management groups, underpinned by cross-border cooperation agreements, have been established. Large, globally operating banks have established Recovery and Resolution Plans. They have worked on removing barriers to resolvability. And resolvability assessments are being conducted to evaluate the credibility and feasibility of resolution strategies. Perhaps the most important thing of all is the planning requirement. As US President Eisenhower said, "plans are worthless, but planning is everything". This is true for all forms of crisis management. Resolution planning for systemic financial firms has helped in identifying and addressing a multitude of legal and operational issues that could form an obstacle to orderly resolution. This has also greatly improved the capabilities of firms and other stakeholders to support resolvability. In a way, resolution can be compared with the work of funeral directors. Nobody wants to die, but when it happens funerals play a useful role in shielding society from, well let's say, the negative externalities of death. Today, implementation of the resolution framework is very advanced, notably in countries that are home to globally systemically important banks. The resolution strategy after failure is relatively clear for very large banks in particular: bail-in and a continuation of operations after, for example, a single resolution weekend. 2/4 BIS - Central bankers' speeches So on paper, everything looks pretty good. But can we really claim success? While resolution has been very important for addressing the too-big-to-fail problem, the orderly resolution of a troubled big bank has not yet been tested. The most high-profile resolution case to date is Banco Popular, a mid-sized Spanish bank that ran into trouble in 2017. In that case, there was a big party, Santander, available that was willing to take over Banco Popular. But there is not always a large buyer available at the right price. Of course earlier this year we had the case of Credit Suisse. In this case, resolution was only partly applied. So-called AT1 bonds were written off, but shareholders, who of course are lower on the creditor hierarchy, did get a part of their money back, 3 billion euro in total. On top of that, the take-over by UBS involved a state guarantee. If UBS were to lose more than 5 billion euro on the acquisition of Credit Suisse, the Swiss state would be good for the next 9 billion. The partial resolution of Credit Suisse was somewhat surprising. According to the Financial Stability Board, financial markets had priced in full resolution. However, the Swiss authorities indicated that they were not sufficiently prepared for that. So the lesson from Credit Suisse is that both resolution authorities and banks should think even harder about life after death. About what is needed to let banks fail in an orderly way without triggering instability in the broader financial system. Because that is a responsibility to which the public holds us accountable. A recent case in our own country that I also want to mention was the bankruptcy of Amsterdam Trade Bank last year, a small bank with a foreign parent. This case is rather atypical in the sense that the cause of the bankruptcy was not bad lending decisions or governance problems, but simply the sanctions against Russia. This led many service providers to stop their services to ATB, forcing the bank to close down. Having said that, this was a rather clearcut case of how we perform resolution of smaller banks in the Netherlands, namely through bankruptcy filing and activation of the deposit guarantee system. In this case, things went very quickly and smoothly, which was important for the credibility of the deposit guarantee system. As a side note, we at the central bank were one of the creditors of ATB. We are 'the bank for the banks' after all, and in that capacity we had monetary policy-related financing outstanding. As you know, assets that are assumed safe can turn worthless overnight in the case of a likely default. So some of our people worked over the Easter weekend to get our money back. I'm happy to say we succeeded. ATB was a small bank, which made resolution relatively straightforward. At mid-sized banks, with more cross-border activities, things will likely be a bit more complicated. In any case, what's clear is that resolution of a mid-sized or large bank in the Netherlands would almost certainly involve a bail-in of both creditors and shareholders. After the financial crisis of 2008, there is simply no public support in Dutch society for rescuing a bank with taxpayers' money. All in all, what we have seen in Europe so far is a variety of tastes in resolving failing banks, preferably outside the European resolution regime, making use of national 3/4 BIS - Central bankers' speeches options. Sometimes effective and efficient, sometimes involving a substantial bail-out, sometimes financed by the state. So it is a good thing that the European Commission has put forward proposals for more streamlining of resolution regimes. Although that does not necessarily have to mean that resolution will be applied automatically to any teetering bank in Europe. We should not forget our final aim, and that is an efficient resolution of a failing bank. I guess the job will never be completely finished, and it is not meant to be. Resolution planning is an ongoing process that has become an indispensable complement to going concern prudential supervision. What that means for you is: memento mori, which as you know is Latin for 'remember that you are mortal'. Go about your going concern banking business like you always have, but: be prepared, get your house in order, just in case. On that rather cheerful note I would now like to conclude, and I am more than happy to take your questions. And in case if you would ever like to work for a bank that cannot go bankrupt, even with an expected deficit in the billions, consider DNB. 4/4 BIS - Central bankers' speeches | netherlands bank | 2,023 | 9 |
Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, at the press conference on the Financial Stability Report, Amsterdam, 9 October 2023. | Klaas Knot: Introduction to the press conference on the Financial Stability Report Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, at the press conference on the Financial Stability Report, Amsterdam, 9 October 2023. *** Good morning everyone and a warm welcome to this press conference on the Financial Stability Report. I would like to start with a brief outline of the key messages from the FSR and I will then be happy to answer your questions. Economic outlook First, let me reflect on the economic outlook. Since the high inflation peak last autumn, inflation has started to decline, but is expected to remain above 2% for some time to come. This is why central banks have been tightening monetary policy further over the past year. With 10 rate hikes in 14 months, the ECB has lifted the policy rate from -0.5% to 4.0%, which is a fast pace viewed from a historical perspective. Rising interest rates have made it more expensive for households and businesses in the Netherlands to borrow money. These tighter financial conditions are becoming increasingly evident in the economy, and they are a necessity if we are to bring inflation back down to our 2% target. As a result, we see economic growth in the Netherlands slowing down. At the same time, the labour market is expected to remain tight in the coming years, keeping unemployment low. This persistent tightness is contributing to higher wage growth and the gradual pace at which inflation is normalising. Risks inherent in transitioning to higher interest rates The rapid transition to higher interest rates also changes the risks to financial stability. In themselves, the higher rates have a positive impact on the financial system. For example, the increase in bank profits and higher funding ratios at pension funds show that higher interest rates are in principle beneficial for financial institutions. Likewise, investors in financial markets seem to have been pricing in risk again recently, reducing their incentives to invest in riskier asset classes. But there is always a flip side: in fact, the transition to higher interest rates may also expose accumulated vulnerabilities and create new risks to financial stability. Let me highlight two key examples of such risks, which are also discussed in the Financial Stability Review. First of all, the transition to higher interest rates impairs the sustainability of government debt, as higher rates cause sovereign debt to weigh more heavily on government budgets. This also applies to Netherlands, although its government debt is still relatively low. Adjustment is needed to ensure future compliance with fiscal rules and have room to pursue stabilising fiscal policies, such as the support measures implemented during the Covid-19 pandemic and to households as compensation for energy price increases in 2022. I therefore support the 17th Fiscal Space Working Group's recommendation to the next cabinet to change the course of fiscal policy. My fellow Executive Board Member Olaf Sleijpen represented DNB in this working group. 1/2 BIS - Central bankers' speeches In addition, we expect credit risks for banks to increase in the coming period. Higher interest rates are driving up refinancing risks, especially for businesses. For example, 56% of total Dutch corporate debt is due to mature or will be subject to an interest rate review within the next two years. These businesses will therefore be facing increasing interest expenses very soon. Also, businesses' debt repayment capacity has deteriorated due to high inflation. Both developments contribute to the increase in banks' credit risks. Furthermore, these risks are reflected in the data with a time lag, making banks vulnerable to potential losses in the future. At the same time, Dutch banks enjoy solid capital positions and DNB has taken macroprudential measures in recent years that contribute to their resilience, such as raising the countercyclical capital buffer. It is important now that banks, in designing their capital policies, also consider the increased risks and their future resilience. Commercial real estate risks With regard to financial institutions' increasing credit risks, I would like to elaborate in particular on the Dutch commercial real estate market. As in other countries, our commercial real estate market is under pressure. For example, transaction values have fallen by 13% since mid-2022 due to both cyclical and structural changes. Construction and financing costs have gone up due to high inflation and high interest rates. In addition, structural changes, such as the increase in remote working and online shopping, are reducing demand for office and retail space. Currently, we do not observe any problems at financial institutions exposed to commercial real estate. At banks, there are no signs of credit risks materialising as yet, but this could change soon if interest rates persistently remain at higher levels. Insurers and pension funds are directly exposed to commercial real estate price declines – in fact, market valuations are reflected immediately in their balance sheets. In this issue of the FSR we specifically consider the risks inherent in real estate investment funds, as pension funds and insurers make a significant proportion of their commercial real estate investments through investment funds. On a positive note, we conclude that risks at Dutch real estate investment funds seem to be well-managed. This is partly because the redemption frequency of these funds matches the illiquid nature of real estate investments. This concludes my introduction. 2/2 BIS - Central bankers' speeches | netherlands bank | 2,023 | 10 |
Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Digital Asset Symposium, hosted jointly by the Bank of England and the Financial Stability Board, London, 10 October 2023. | Steven Maijoor: Crypto-assets regulation - from patchwork to framework Speech by Mr Steven Maijoor, Executive Director of Supervision of the Netherlands Bank, at the Digital Asset Symposium, hosted jointly by the Bank of England and the Financial Stability Board, London, 10 October 2023. *** Hello everyone – offline, and also, hello everyone online. It is a pleasure to be back in London. Back at the Bank of England. Back at the 'Old Lady of Threadneedle Street'. The Old Lady that battles inflation, safeguards financial stability and firmly protects- the gold in her vaults. Gold that lies right here, under our feet. 400 000 bars of gold, to be precise. And part of that gold- is Dutch (more information). Now, I am not here to take a peek at that small fraction of gold that is ours. No, today, I was invited to talk about a new type of gold – or, at least, to some it is. I am referring to crypto-assets. Something the Financial Stability Board has consistently been monitoring since 2018 (more information). For a long time, crypto-assets were an experiment on the fringes of the financial system. No shop owner would accept bits and bytes instead of cash or card. But soon, certain illicit online marketplaces got wind of this new digital asset: selling illegal services or products online had never been this easy. So, regulators and law enforcement agencies sprang into action and took coordinated action to combat money laundering. Nonetheless, in those early days, chances were very slim that someone had heard of bitcoin or ether, let alone owned them. And then suddenly – seemingly overnight – crypto-assets became the talk of the town, and everybody seemed to wonder: is this the new gold? As a result, the total market capitalization of crypto-assets exploded (more information). At the same time, ties with traditional financial parties grew. As did the interest in the underlying technologies. When the 'crypto winter' hit us last year, it became crystal clear however, that not all that glitters is gold. A sudden change in investor sentiment caused a sharp decrease in crypto-asset prices. That, in turn, led to the spectacular failure of several cryptointermediaries. Total crypto-asset market capitalization was never really able to recover after that. But even as crypto-asset prices are in a rut presently, crypto-asset market structures continue to develop at a rapid pace. And at the same time, we see a growing involvement of traditional finance with the crypto-ecosystem – which means that the financial interlinkages between these two worlds are growing as well. So we cannot exclude that, sooner rather than later, vulnerabilities in crypto-asset markets become big enough to form an actual, transmissible risk to global financial stability. And this risk looms larger if we don't implement comprehensive regulation. 1/4 BIS - Central bankers' speeches All over the world, national regulators have not been waiting on me to say this. A lot of decisive action has been taken already. The FSB welcomes these initiatives because they show much-needed willingness to act. But at the same time, we see a challenge due to crypto's inherent global reach. And that is: how do we ensure consistency between all these regulations? And how do we deal with crypto parties that choose to operate exactly from those jurisdictions that don't really prioritise the effective regulation and supervision of crypto-asset activities? To overcome these challenges, the FSB developed a Global Regulatory Framework. This framework, published last July, aims to promote the consistency of regulatory and supervisory practices to address the financial stability risks of crypto-asset activities ( more information). Developing this framework on the basis of consensus among the FSB member authorities has required a careful threading of the needle. And so, I think it is fitting that we find ourselves on Threadneedle Street, today. The perfect place to discuss the FSB's finalized policy work on broader crypto-asset markets and global stablecoin arrangements. The latter is a specific type of crypto-asset – one that aims to maintain a stable value relative to a pool of assets, usually fiat money. One that carries heightened risks to global financial stability because of its potential systemic relevance in multiple jurisdictions. And so, one that requires special attention. Because the FSB recommendations are high-level, national authorities can apply these recommendations flexibly, whilst also ensuring a baseline – a baseline that provides for a consistent application of comprehensive regulation across the globe. A baseline that embraces both already existing rules in some countries, and to be drafted regulations in others. A baseline with a clear thread of gold – and that is the principle of "same activity, same risk, same regulation". Many crypto-asset activities perform functions and, hence, carry risks, that strongly resemble those of traditional financial activities. Think, for example, of the similarities between staking and deposit-taking, or between crypto-lending and securities financing transactions. And so, we believe they should be regulated as such. A number of our recommendations have to do with the vulnerabilities of centralized crypto-asset intermediaries. And I stress 'centralized' because, however 'de-centralized' the crypto-asset ecosystem claims to be, economic reality tells a different story. In fact, some of these intermediaries already seem to play a systemic role within the cryptoecosystem. That is why we recommend that authorities require a number of things from these entities. For instance to have in place robust governance frameworks and to set up risk management practices. Of course, I know that implementation takes time. But I also know it's high time – as I have often heard my British colleagues say – to 'crack on'. So, let's prioritise the full and consistent implementation of our high-level recommendations. Because in the meantime, people investing in crypto-assets continue to run serious risks. In the meantime, linkages between the crypto-ecosystem and traditional finance may very well continue to grow. So, in the meantime, risks to financial stability can still escalate. 2/4 BIS - Central bankers' speeches There are several ways through which we can prevent crypto-asset volatility from spilling over to the traditional financial system. One important way to do this, is with the full and consistent implementation of the BCBS prudential framework for the treatment of banks' crypto-asset exposures. Putting this global framework into practice limits the chance that crypto-volatility reaches banks and hence becomes a threat to financial stability. To keep a close eye on the progress made, the FSB will start monitoring implementation. Our first review should be finalized by the end of 2025. And the FSB will not only monitor progress. If we are serious about regulating what is essentially a cross-border phenomenon, we also need to be serious about cross-border cooperation. About information sharing. About working together. This also means that we need to venture outside of the FSB jurisdictions. Because several jurisdictions with material crypto-asset activities are not members of the FSB. Nevertheless, global financial stability ties all of us together. And to safeguard that stability, the FSB members need to engage with these jurisdictions. We need to ensure the needle of their regulatory compass points in the same direction as ours. To do so, we want to start with positive incentives like outreach, technical workshops, and capacity building to get them prepared. We'll work closely with the IMF, the World Bank and other international organizations on this. However, chances are we may still see regulatory competition. And so, we cannot exclude that a toughening of regulation in one part of the world pushes crypto-asset parties to relocate to other parts of the world. Parts of the world with weaker regulatory standards. What we can do, though, is require that traditional financial institutions take additional measures to manage the risks of interacting with crypto intermediaries operating in such jurisdictions. Measures necessary to protect global financial stability. We are not there yet, but if you ask me, we should be heading in that direction. Just like crypto-asset threats don't stop at national borders, the thread of crypto-asset risks doesn't only weave through financial stability. There are also macroeconomic risks. Specifically for emerging markets and developing countries. In EMDEs, crypto-assets are relatively popular. The more popular they are, the more they could erode the effectiveness of domestic monetary policy. Because people may start preferring crypto-assets or stablecoins over domestic currencies. This risk of currency substitution, or so-called 'crypto-ization', means EMDE's might face even greater risks from crypto-assets than advanced economies. A potentially dangerous cocktail of financial stability and macroeconomic risks. For this reason, the Indian G20 Presidency asked the FSB and the IMF to combine their work on this subject in a synthesis paper. This was published in September. A key conclusion is that crypto-assets do indeed have implications for macroeconomic and 3/4 BIS - Central bankers' speeches financial stability, but even more, that these implications are mutually interactive and reinforcing. In our view, this underlines, once more, the need for a global regulatory and supervisory baseline to oversee crypto-asset activities. A baseline that addresses both financial stability and macroeconomic risks. A baseline that all national regulators can adhere to, but at the same time allows them to take targeted and time-bound measures to address jurisdiction-specific circumstances. To help EMDEs address these serious risks to financial stability, the FSB will investigate how cross-border cooperation between advanced and developing economies can practically be enhanced. Dear colleagues, today, I've talked about crypto-assets – a concept that is not even 20 years old. The Bank of England's nickname, the 'Old Lady of Threadneedle Street', dates back more than two hundred years. To 1797. When crypto-assets were still the distant future. Banknotes could still be converted to gold. And France declared war on Britain, and landed on its shores. Within hours, people rushed to the Bank of England. Asking for gold. The very gold that lies under our feet. And the famous vaults were rapidly emptying out. Then-prime minister, William Pitt the Younger, tried to put a halt to that. Not because he wanted to preserve gold for financial stability reasons, but to use it to defend Britain. In a famous cartoon, probably familiar to many of you, you can see William Pitt the Younger trying to 'woo' an old lady (more information). But in fact, all he wants, is the gold in her pockets and in the chest she sits on. Of course, she is not inclined to give in. Ever since, the Bank of England has been known as the 'Old Lady of Threadneedle Street'. Today, the 'Old Ladies' many of us work for, will no longer exchange banknotes for gold. But still people look for stable assets – assets that maintain their value over time and allow them to transact with people from around the globe. Today, these 'Old Ladies', can still not easily be 'woo-ed'. And remain firmly seated on their chests of gold – or, rather, vaults. And today, once more, these 'Old Ladies' are willing to defend what knits us all together and helps to bring global prosperity – and that's financial stability. Thank you. 4/4 BIS - Central bankers' speeches | netherlands bank | 2,023 | 10 |
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Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, at the European Central Bank fifth Macroprudential Policy and Research conference, jointly organised with the International Monetary Fund, Frankfurt am Main, 17 October 2023. | Klaas Knot: Introductory remarks - ECB Fifth Macroprudential Policy and Research conference Introductory remarks by Mr Klaas Knot, President of the Netherlands Bank, at the European Central Bank fifth Macroprudential Policy and Research conference, jointly organised with the International Monetary Fund, Frankfurt am Main, 17 October 2023. *** Many thanks for the kind introduction, Tobias. It is a pleasure to be here. I have little time to cover a fascinating and complex topic, so let me focus on just a few high level issues regarding the effective use and the challenges of macro-prudential policy. We tend to forget that macro-prudential policy is still a relatively new field of work that originated from the Great Financial Crisis. At that point in time, we first needed to design tools to fix the faultiness in the system. The focus then shifted from design to implementation. The challenges of macro-prudential policy are therefore evolving. And now we are at a stage where the onus lies on actually using the tools and to evaluate their effectiveness and efficiency. Including in the face of new risks. So what I intend to do in my opening remarks is to first discuss some of the challenges in implementing the existing macro-prudential toolbox, where I will mainly draw on our experiences within the Eurosystem. I will then move on to the new frontiers of macroprudential policy development, which are arguably global in nature and where the FSB, jointly with the IMF, has a leading role to play. Challenges On the challenge of using macro-prudential tools, there is still room for improvement. For instance, euro area jurisdictions differ in how they apply macro-prudential tools in practice. In Europe, we have a harmonised framework for identifying D-SIBs. There is however no further guidance on buffer calibration. As a result, two banks with similar scores for indicators of systemic importance such as size-to-GDP, interconnectedness, and lack of substitutability, can end up facing quite different requirements. Most big banks in the euro area fall in a range of D-SIB allocations of roughly 1-2.5% of risk weighted assets, but some allocations bear no apparent relationship to the scores that were assigned. I think it is important to further investigate such heterogeneity and what mechanisms could be put in place to correct for this in order to ensure a level playing field. On evaluating the effectiveness and efficiency of macro-prudential tools, I believe the main challenge is to ensure that the regulatory framework remains sufficiently capable of addressing systemic risks. Especially in an ever-changing financial sector. This is why we should keep an open mind to developing the framework further. Against that background, allow me to highlight some lessons from the last couple of years. First, it is equally important to understand what macro-prudential policy can and cannot do. The current macro-prudential toolkit, at least in the Netherlands, is mainly geared toward building bank buffers and resilience. However, the macro-prudential authority 1/4 BIS - Central bankers' speeches should ideally also have sufficient tools at its disposal to limit the cyclical build-up of excessive risks at a much earlier stage. I am thinking here, for example, of borrowerbased measures. Of course, that theme interacts with political economy deliberations, a reason why I will not dwell on that any further here. Second, the Covid pandemic showed us the great value of having sufficient capital buffers that can be released. This capital should supplement a sufficiently large layer of structural buffers, and can be used in response to a shock. Thereby giving banks extra room to absorb losses and keep credit flowing. Against this background, in the Netherlands we decided to revise our framework to target a 2% Countercyclical Capital Buffer in an environment in which risks are neither subdued nor elevated, known elsewhere as a 'positive neutral rate'. This brings me to my third lesson, which is that there is great merit in building buffers early on. After all, by building capital in times when risks are slowly on the rise, when financial conditions are favourable, and when bank profitability is there, we are able to prepare the sector for worse times and avoid difficult situations later on, such as the one in which regulators may want to increase capital requirements but fear the procyclical effects this could bring about. In the same vein, there is merit in taking better account of both the benefits and costs of capital requirements when determining the right policy mix. This consideration is also relevant at this juncture, where profits in the European banking sector are looking rather healthy still, while uncertainty about the future macro-financial environment is on the rise. It is clear that we have come a long way. At the same time, I am convinced that macroprudential policy will continue to involve making difficult decisions based to some degree on expert judgement, in an uncertain environment. Decisions that are sometimes not so popular. That is why it is important to communicate clearly with the sector and the public at large. This can make macro-prudential policy more acceptable and, hence, more effective. Looking forward, the recent banking turmoil in March drives home the question of whether our policy tools are sufficient to counter the macro-prudential risk of a systemic liquidity crisis. Furthermore, specifically for Europe, we also have to ask ourselves whether having a true banking union warrants further consistency in national practices, for example with respect to the use and application of the CCyB, and reflect on whether a counter-cyclical macro-prudential tool at the European level is also warranted. New Frontiers Let me now turn to the new frontiers of macro-prudential policy, including non-bank financial institutions, or NBFIs, crypto-assets and climate. All these areas affect our financial stability, requiring action. NBFIs, particularly investment funds, have shown their potential to generate systemic risk in the past – Long Term Capital Management in 1998 – and more recently – the March 2020 turmoil, the Archegos collapse, and the UK Gilt-market episode. 2/4 BIS - Central bankers' speeches While it is clear that crypto-asset markets cannot be considered systemically relevant at present, traditional financial institutions have been expanding their participation in these markets. This is worrisome from a global financial stability perspective considering crypto's inherent volatility and global reach. On climate change, just this summer we have witnessed a range of extreme weather events across Europe, from wildfires to torrential rain and floods, presenting a stark reminder of the systemic dimension of climate change. In addition to extreme events, a disorderly transition to a low-carbon economy could also have destabilising effects. Macro-prudential policy can play a role in addressing these risks. But as with anything new, developing macro-prudential policy in these areas comes with challenges. The NBFI and crypto-asset sectors are characterised by a great variety of entities, activities and business models. A one-size-fits-all approach to enhancing its structural and cyclical resilience is therefore unlikely to be successful. And in both these cases, it is difficult to properly gauge systemic risk due to data gaps and a lack of harmonised analytical tools. With respect to climate change, the uncertainty is perhaps even greater, as it is difficult to know how and when climate-related risks will materialise. Given the inherently cross-border nature of activities and risks in all these areas, global coordination and consistency are of the utmost importance to avoid risks merely shifting elsewhere. So how should we approach these new frontiers? Let me highlight some considerations for macro-prudential policy in NBFI, as this is probably the area where discussions are most advanced at this stage. As in the banking sector, macro-prudential policy for NBFI should seek to prevent the build-up of risks, make the financial sector more resilient and limit contagion by focusing on the system as a whole. However, although the objective is similar, the approach may be different. This is due to the nature of systemic risk in NBFI. Taking the example of investment funds: whereas systemic risk in the banking sector often revolves around the solvency of individual entities, systemic risk in the investment fund sector generally revolves around liquidity imbalances arising as a result of collective actions of cohorts of funds generating sharp spikes in liquidity demand. Therefore, the practice of applying higher requirements to systemically important institutions, such as higher capital buffers, is unlikely to be the central feature of macro-prudential policy in NBFI. A macro-prudential approach to investment funds should therefore primarily be activitybased, rather than entity-based, and include requirements applying to all entities within a specific cohort, regardless of their individual systemic relevance. In this way, macroprudential policy would presumably raise the baseline of existing micro-prudential requirements at the fund level by embedding the macro-prudential perspective. This would allow funds to internalise their potential impact on the wider financial system. Looking ahead, I see three components in the evolution of macro-prudential policy for NBFI. 3/4 BIS - Central bankers' speeches First, we should finish important parts of the ongoing work to address structural vulnerabilities. Following the March 2020 market turmoil, analytical and policy work at the FSB level has focused on enhancing MMF resilience, liquidity mismatch in openended funds, the excessive use of leverage, and liquidity preparedness in the context of margin calls. Work is still ongoing in multiple areas. Importantly, this includes assessing whether existing tools can be repurposed by embedding the macro-prudential perspective, which would likely lead to raising the baseline of existing requirements. Second, we should focus on enhancing capabilities in the area of data availability, governance and analytical tools to adequately gauge systemic risk. In addition to a solid micro-prudential foundation, this is the key to any macro-prudential approach. It is hard to front-load macro-prudential policy in the fog. Third, we should assess the need for additional macro-prudential tools, including in the hands of authorities, to address any remaining risks that are not mitigated by embedding the macro-prudential perspective in existing regulation. The approach for crypto-assets is fairly similar, in that the focus should be on building micro-prudential regulation first and making sure it is globally consistent to avoid arbitrage. We also need to close data gaps and improve our understanding of systemic risk in this sector, including the potential for spillovers to banks and more traditional asset classes. In the case of climate, the existing banking macro-prudential toolkit already provides a starting point, but needs fine-tuning to better capture climate-related risks and prevent them from building up, to build resilience in case these risks materialise, or both. Let me stop here. 4/4 BIS - Central bankers' speeches | netherlands bank | 2,023 | 10 |
Speech by Mr Klaas Knot, President of the Netherlands Bank, at the 26th Annual DNB Research Conference "Challenges for monetary policy that make us think", Amsterdam, 2 November 2023. | Klaas Knot: Challenges for monetary policy that make us think Speech by Mr Klaas Knot, President of the Netherlands Bank, at the 26th Annual DNB Research Conference "Challenges for monetary policy that make us think", Amsterdam, 2 November 2023. *** Welcome everyone! Every year scientists, researchers, authors and economists all over the world eagerly await the awarding of the Nobel prizes. But did you know there is a satiric version of these prizes, called the Ig Nobels? Since 1991, the Ig Nobels have been awarded to honour achievements in scientific research that first make people laugh, and then make them think.The Ig Nobels are organised by the satirical scholarly journal 'Annals of improbable research', the annual ceremony is held at Harvard University,there are ten prizes every year for a variety of scientific fields, presented by genuine Nobel laureates, and the prize is 10 trillion Zimbabwean dollars from a time of hyperinflation. And the honour, of course-. Yes, some of the winning research seems very trivial and totally irrelevant. For instance the project that concluded that black holes fulfil all the technical requirements for being the location of Hell...Or the discovery that fleas living on a dog can jump higher than fleas living on a cat-Or the winner of the 2005 Ig Nobel prize in Economics who invented Clocky: an alarm clock that runs away and hides, repeatedly, to ensure that people get out of bed and have a more productive dayBut there is a noble side to the Ig Nobels: history shows that seemingly trivial research sometimes leads to important breakthroughs. A good example is the experiment that won André Geim and Michael Berry an Ig Nobel in 2000: how to levitate a frog with magnets. It seemed weird and trivial, but the experiment showed that the magnetism of water is strong enough to counter gravity. That insight became part of the inspiration for China's lunar gravity research. And of course, Geim won a real Nobel prize – for Physics – in 2010. No, I am not saying that the research papers you will present today are trivial in any way, shape or form, but we all know that every invention, every discovery, every research project has to start somewhere. Just like every change has to start somewhere. Mostly with eventsAnd recent years have been truly eventful. The euro area economy was rocked by several large shocks, – the Global Financial Crisis (GFC), the European sovereign debt crisis and a pandemic that kept the economy in lockdown. And more recently, Russia's unjustifiable war in Ukraine that caused energy prices to spike and inflation to soar. Shocks that have challenged central banks all over the world in their quest for price stability. Shocks that have challenged us to find new instruments, to expand our toolkit to counter the deflationary dynamics and enable governments to engage in fiscal 1/3 BIS - Central bankers' speeches stimulus. A challenge that we met by deploying several unconventional monetary instruments, including forward guidance, asset purchases and longer term refinancing operations. Did they work? Yes, they certainly left their mark. Forward guidance and asset purchases lowered medium to long-term interest rates, making credit more affordable and boosting the economy. TLTROs significantly reduced banks' funding cost, and stimulated banks to pass on these favorable funding costs to businesses and households. These measures are now an integral part of the central bank's toolbox; they add policy space when rates are at the lower bound, even though they are not unbounded themselves. Yet, as we have found out, they also come with a challenge: the combination of instruments and the sequencing we ourselves imposed have created a very high degree of persistence in our monetary policy. In other words: it reduced our ability to 'turn the ship' when inflation flared up. Why was that? The moment policy makers could effectively raise rates was delayed because we communicated that the we would first stop with net asset purchases before raising rates. And stopping asset purchases takes time. They were a novel, untested instrument. And as Brainard argued: uncertainty regarding an instrument calls for smaller steps. So, to 'turn the ship', we started by gradually reducing the net asset purchases to zero under the PEPP and APP. After that, in July 2022, we were 'free' to raise rates for the first time. What followed was a rise of policy rates at an unprecedented pace: between July 2022 to September 2023, policy rates increased by a total of 450 basis points from minus 0.5 percent to 4 percent today. Restrictive policies will likely remain needed for some time to come to get inflation back down to target. Personally, and conditional on incoming data confirming the latest projections from September, I see the current level of our policy rates as a good 'cruising altitude' where they can remain for some time. And that brings me to another challenge: the right calibration of our monetary policy to strike a balance between doing too much and doing too little. Why is that a challenge? First, you are all aware of the long and variable 'transmission lag' of monetary policy between one and two years. In other words: the effects of the policy tightening on the real economy - think about investment, GDP, unemployment – will only be felt in about one year's time. Hence, we should be a little patient and not raise rates too much to prevent choking off the economy. Second, even though inflation numbers have started to decrease, the risk still remains that high inflation may become entrenched if second round effects persist or inflation expectations de-anchor. 2/3 BIS - Central bankers' speeches Therefore, we need the incoming data to continue to confirm our projections – which have not been the best in an environment of major shocks – if we are to have confidence in them. There is one other challenge I want to mention: the size of the central bank balance sheets. More than a decade of implementing 'unconventional monetary policy' tools has increased central banks' footprint in financial markets in an unprecedented fashion. As we have stopped reinvesting the principal payments from maturing securities under the APP, the Eurosystem's balance sheet is now shrinking at a measurable pace. Under both the APP and PEPP, we bought billions in sovereign bonds with an average maturity of about 7 years. Some of these bonds are now maturing: that means the 'principal' of our investments is flowing back to us. Through this process, excess liquidity is drained form the system. However, we currently still reinvest the principal payments for the PEPP, leaving the overall bond portfolio unchanged. To date, this 'quantitative tightening' has been smooth and well-absorbed by financial markets. This is similar to what we see from our international peers, who – in fact – are reducing their balance sheet at a relatively faster pace. That brings me to the challenge. While, clearly, the current balance sheet has to shrink, our future balance sheet size may need to be larger than it was before the Global Financial crisis. The reason is that structural changes in financial markets, including a higher demand for liquidity, will call for a larger central bank reserves in the future. In my view, refinancing operations represent the most efficient tool to provide such a level of reserves down the road. For all these challenges, I look forward to your ideas, your expertise, your input. Because monetary policy is too important, too crucial for our economy and our general well-being, to rely on trial and error. The ECB, the central banks, would prefer to avoid the honour of receiving an Ig Nobel prize. Yes, in the history of the Ig Nobel prizes some were also awarded as criticism wrapped up in a blanket of satire. For instance, in 2009, the Ig Nobel for Economics was awarded to the directors, executives, and auditors of four Icelandic banks for demonstrating that tiny banks can rapidly mushroom into huge banks, and vice versa, and for demonstrating that similar things can happen to an entire national economy. So, to avoid that 'honour', we need data and research to fulfil our mandate, so that we can do the best possible job at what we must do best. Because in monetary policy, we cannot live by the slogan of the Ig Nobel prizes, also the closing remark of the annual ceremony: "If you didn't win a prize – and especially if you did – better luck next year! " So, make us think! 3/3 BIS - Central bankers' speeches | netherlands bank | 2,023 | 11 |
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