Macroprudential Bulletin - Interview with Vítor Constâncio

The Macroprudential Bulletin was established in 2016 and, today, we see the publication of the fifth issue. What goals did you wish to achieve with the Bulletin? Why was it created?

The Macroprudential Bulletin was established to close a gap in the communication of macroprudential analysis and policies in the euro area. It seems that the public was not generally aware that the Single Supervisory Mechanism (SSM) Regulation confers specific powers and responsibilities on the ECB in the field of macroprudential policy, exercised jointly with the national competent authorities. The Bulletin was created to help raise public awareness of this important mandate given to the ECB, which is a necessary complement to monetary policy. Indeed, macroprudential policy provides selective and targeted instruments that can be useful for addressing more localised financial risks affecting specific sectors or countries. The Bulletin is our communication tool for explaining the ECB’s macroprudential policy framework and decision-making procedures (see Issue 1 of the Macroprudential Bulletin). At the same time, the Bulletin is directed to the community of researchers in macroprudential topics by publishing our results in developing analytical tools and methodologies to be used in policy design. It also provides transparency on what we are doing in the field of macroprudential policy. Finally, the Bulletin is a publication used to express our views on macroprudential and regulatory policy, for example the EU banking reform package.

The Macroprudential Bulletin is presented in a completely new design on the ECB’s website. What do you expect from the new format?

The overall aim of the new-look Bulletin is to offer the reader a more attractive publication. Each article will now be available at one click, so that the content can be accessed much more quickly than before. Readers can also find our articles more easily via search engines and on the “IDEAS” research platform. The format is more user-friendly as well, as it is better suited to the screen sizes of tablets and smartphones. In short, the new-look Bulletin should help to increase the visibility of macroprudential topics and raise public awareness of their importance.

The article on the macroprudential framework, in this issue of the Macroprudential Bulletin, calls for a thorough review of the existing rules. Which changes would you support in the short and medium term, and why?

Let me start by emphasising that financial regulation and a well-functioning macroprudential framework are preconditions for safeguarding financial stability, which in turn contributes to protecting the Single Market. We already have a macroprudential framework in place – set out in the Capital Requirements Regulation and Directive (CRR/CRD IV), and the ESRB and SSM Regulations – but, as further experience with the framework is gained, the rules need to be continuously revised to make sure they are fit for purpose.

The ongoing revision of the CRR/CRD IV provides an opportunity to build on the lessons learned from the experience gained so far, by introducing targeted changes to the macroprudential framework. Key priorities in this regard include: (i) delineating the roles and responsibilities of macro- and microprudential authorities, so that both types of authorities can control a distinct set of instruments and deliver on their mandates; (ii) eliminating overlaps between instruments and increasing flexibility in the capital buffer framework, so that authorities can implement those measures in a consistent and timely manner; (iii) streamlining the activation procedures, where these do not add value in terms of safeguarding the Single Market; and (iv) providing a review clause to allow for further adjustments in the future.

However, this should only be the first step towards a more thorough revision of the framework in the medium term. A comprehensive review would allow a reduction in the complexity of the toolkit, enhancing the coherence of the policy framework, as well as its expansion to incorporate new instruments where necessary. Such a comprehensive review should include complementing the toolkit with borrower-based instruments (such as limits on loan-to-value or loan-to-income ratios), as well as sectoral buffers and a time-varying leverage ratio add-on, so that all aspects of systemic risks in the banking sector can be addressed. Furthermore, the toolkit should be extended to non-banks to capture risks in those areas and to avoid regulatory arbitrage across sectors. Finally, I consider it important that the mandatory reciprocity framework is expanded so as to ensure the effective mitigation of cross-border spillover effects and regulatory arbitrage across jurisdictions in the European Union.

The analytical topics look at interlinkages between euro area banks, as well as between banks and investment funds. What are the key findings of these analyses?

To better understand the interlinkages between euro area banks, the first article assesses banks’ interconnections via large exposures. In the euro area interbank market, there are a few core banks that are highly connected with each other and many other banks that are less interconnected. The core banks also tend to have higher levels of cross-border activity than the other banks. For financial stability, it is imperative that the core banks that are systemically important for interbank lending are stable. In order to identify these banks, size-based measures and model-based measures, which draw on information across the entire network and a more sophisticated set of assumptions, are used.

The key finding is that those different measures correlate strongly on average, which allows robust identification of banks critical to the interbank market. In order to ensure the resilience of the banks identified, policymakers may impose additional own funds requirements on them, known as the “other systemically important institutions buffer”. The second finding of the analysis relates to the calibration of such buffers and suggests that policymakers should take into account (model-based) network measures of interconnectedness, in addition to the size-based indicators, as the size-based measures may deviate considerably for some banks.

The second article analyses the development of exposures within the European financial system more broadly. The analysis documents changes in the distribution of risk across the bank and asset management sector. Evidence regarding banks’ and investment funds’ tolerance for credit and liquidity risk reveals that banks have reduced the average credit risk of their securities portfolio since the first quarter of 2014, while the average credit risk of investment funds has, in the same period, been moving around a two-year trend. It appears that banks in the euro area have, on average, shifted their holdings into safer assets. Looking at liquidity risk in the sectors, significant differences in levels can be observed, investment funds being, in general, more reluctant to hold liquidity risk. The analysis also confirms that higher capital requirements make the banking sector as a whole more reluctant to hold risky assets and thereby contribute to increasing banks' portfolio share in safe assets. While higher capital requirements are crucial for the resilience of the banking sector, this new evidence suggests that they may also contribute to the shift in market shares and change in the composition of assets across the financial system. These findings therefore highlight the need to monitor these structural shifts in the market, in particular the migration of systemic risk to the non-bank financial sector and the need to adequately regulate this sector, also through macroprudential policies.

Drawing a comparison with the microprudential tasks of the ECB, observers have perceived the ECB as not being very active in the field of macroprudential policy. Is this perception true?

This is definitely a wrong perception. The macroprudential policy area of the ECB has certainly been quite active. However, as the national designated authorities or national competent authorities are expected to react pro-actively to the specific conditions in their respective countries, the public focus is rightly on the actual decisions and their communication by national authorities. The fact that the ECB only has the power to tighten or reject macroprudential measures set out in EU legislation also contributes to this perception. The ECB does not publicly comment on these decisions or publish them in parallel on an ad hoc basis. However, what may be less known by the public is that these national decisions on the use of macroprudential instruments have undergone intense discussion at the technical and policy levels in the Eurosystem, as they may have implications across the SSM rather than in an individual country. The ECB leads these meetings and prepares the discussions at the Eurosystem level, for example by analysing cross-border effects. So, in short, these shared responsibilities for macroprudential policy in the euro area may be the reason why observers have perceived the ECB to be less active.

Where do you see the key open issues for the broader financial stability framework in the euro area?

There are still many open issues with the existing framework to safeguard financial stability in the euro area: the ongoing risk reduction in the banking system needs to be accompanied by commensurate risk sharing, for example by completing the banking union with a European Deposit Insurance Scheme and with a credible backstop to the Single Resolution Fund; the Basel III package still needs to be implemented in Europe and the capital markets union needs to be pursued with more ambition. I could easily extend this list, adding many other issues to it, such as the macroprudential framework, which should be revised to align the rules with the changing institutional set-up and to enable authorities to address new types of systemic risk in the banking and non-banking sectors. The banking union seems to be at a crossroads that will determine its future direction. I think that the euro area countries needs to find convincing answers to these open issues in order to ensure financial stability in the euro area and the continuity of the banking union.