25. Third, the "central bank money solution". This is the lender-of- last-resort issue that has brought the Eurosystem under vigorous criticism by distinguished academics and the IMF's Capital Markets Division of the Research Department. The criticism has been that the alleged absence of a clear and transparent mechanism to act in an emergency raises doubts in the markets about the ability of the Eurosystem to handle crisis situations. It is said that the uncertainty generated by the present arrangements would entail new risks, including the possibility of investors requiring an additional risk premium at times of financial market volatility and, ultimately, of the credibility of EMU being damaged. Two examples of these concerns deserve an explicit mention. The IMF "Report on Capital Markets", September 1998, stated that "it is unclear how a bank crisis would be handled under the current institutional framework …which is not likely to be sustainable". Similarly, the first report of the CEPR (Centre for Economic Policy Research) on monitoring the ECB entitled "The ECB: Safe at Any Speed?" expressly suggested that the Eurosystem lacks crisis management capacity and is too rigid to pass the A-Class test to keep the vehicle on the road at the first steep turn in financial market conditions in Europe.
26. My response to this criticism is threefold. To my mind, the criticism reflects a notion of lender-of-last-resort operations that is largely outdated; it underestimates the Eurosystem's capacity to act; and, finally, it represents too mechanistic a view of how a crisis is, and should be, managed in practice.
27. The notion of a central bank's lender-of-last-resort function dates back more than 120 years, to the time of Bagehot. This notion refers to emergency lending to institutions that, although solvent, suffer a rapid liquidity outflow due to a sudden collapse in depositors' confidence, i.e. a classic bank run. A bank could be exposed to depositors' panic even if solvent because of the limited amount of bank liquidity and an information asymmetry between the depositors and the bank concerning the quality of bank's assets that do not have a secondary market value.
Nowadays and in our industrial economies, runs may occur mainly in textbooks. They have little relevance in reality because, since Bagehot, many antidotes have been adopted: deposit insurance, the regulation of capital adequacy and large exposures, improved licensing and supervisory standards all contribute to the preservation of depositors' confidence and minimise the threat of a contagion from insolvent to solvent institutions.
A less unlikely case is a rapid outflow of uninsured interbank liabilities. However, since interbank counterparties are much better informed than depositors, this event would typically require the market to have a strong suspicion that the bank is actually insolvent. If such a suspicion were to be unfounded and not generalised, the width and depth of today's interbank market is such that other institutions would probably replace (possibly with the encouragement of the public authorities as described above) those which withdraw their funds. It should be noted, in this respect, that the emergence of the single euro money market lowers banks' liquidity risk, because the number of possible sources of funds is now considerably larger than in the past.
Given all of these contingencies, the probability that a modern bank is solvent, but illiquid, and at the same time lacks sufficient collateral to obtain regular central bank funding, is, in my view, quite small. The textbook case for emergency liquidity assistance to individual solvent institutions has, as a matter of fact, been a most rare event in industrial countries over the past decades.
28. What if this rare event were nevertheless to occur and cause a systemic threat? The clear answer is that the euro area authorities would have the necessary capacity to act. This is not only my judgement, but also that of the Eurosystem, whose decision-making bodies have, as you can imagine, carefully discussed the matter. I am not saying that we are, or shall be, infallible; no one can claim such a divine quality. I am saying that there are neither legal-cum-institutional, nor organisational, nor intellectual impediments to acting when needed. In stating this, I am aware that central banks may be the only source of immediate and adequate funds when a crisis requires swift action, while solvency remains an issue and failure to act could threaten the stability of the financial system.
In these circumstances the various national arrangements would continue to apply, including those concerning the access of central banks to supervisors' confidential information. As is well known, such arrangements differ somewhat from country to country.
29. The criticism I have referred to also underestimates the Eurosystem's capacity to act. To the extent that there would be an overall liquidity effect that is relevant for monetary policy or a financial stability implication for the euro area, the Eurosystem itself would be actively involved.
The Eurosystem is, of course, well equipped for its two collective decision-making bodies (the Board and the Council) to take decisions quickly whenever needed, whether for financial stability or for other reasons. This readiness is needed for a variety of typical central bank decisions, such as the execution of concerted interventions or the handling of payment system problems. Indeed, it has already been put to work during the changeover weekend and in the first few weeks of this year.
A clear reassurance about the capacity to act when really needed should be sufficient for the markets. Indeed, it may even be advisable not to spell out beforehand the procedural and practical details of emergency actions. As Gerry Corrigan once put it, maintaining "constructive ambiguity" in these matters may help to reduce the moral hazard associated with a safety net. I know of no central bank law within which the lender-of- last-resort function is explicitly defined.
The question of who acts within the Eurosystem should also be irrelevant for the markets, given that any supervised institution has an unambiguously identified supervisor and national central bank. As to the access to supervisory information, the lack of direct access by the Eurosystem should not be regarded as a specific flaw of the euro area's institutional framework, as has been frequently argued, since this situation also exists at the national level wherever a central bank does not carry out day-to-day supervision.
30. Finally, the criticism reflects an overly mechanistic view of how a crisis is, and should be, managed in practice. Arguing in favour of fully disclosed, rule-based policies in order to manage crises successfully and, hence, maintain market confidence, is almost self-contradictory. Emergency situations always contain unforeseen events and novel features, and emergency, by its very nature, is something that allows and even requires a departure from the rules and procedures adopted for normal times or even in the previous crisis. Who cares so much about the red light when there is two metres of snow on the road? As for transparency and accountability, these two sacrosanct requirements should not be pushed to the point of being detrimental to the very objective for which a policy instrument is created. Full explanations of the actions taken and procedures followed may be appropriate ex post, but unnecessary and undesirable ex ante.
31. So far, I have focused on the provision of emergency liquidity to a bank. This is not the only case, however, in which central bank money may have to be created to avoid a systemic crisis. A general liquidity "dry-up" may reflect, for example, a gridlock in the payment system or a sudden drop in stock market prices. The actions of the Federal Reserve in response to the stock market crash of 1987 is an often cited example of a successful central bank operation used to prevent a dangerous market-wide liquidity shortfall. This kind of action is close to the monetary policy function and has been called the "market operations approach" to lending of last resort. In such cases, liquidity shortfalls could be covered through collateralised intraday or overnight credit, or auctioning extra liquidity to the market. The Eurosystem is prepared to handle this kind of market disturbance.
VI. CONCLUSION
32. In my remarks this evening, I have looked at the euro area as one that has a central bank which does not carry out banking supervision. This would be normal, because in many countries banking supervision is not a task of the central bank. What is unique is that the areas of jurisdiction of monetary policy and of banking supervision do not coincide. This situation requires, first of all, the establishment of smooth co-operation between the Eurosystem and the national banking supervisors, as is the case at the national level where the two functions are separated. The most prominent reason for this is, of course, the scenario where the provision of liquidity from the central bank has to be made in a situation that is generated by problems of interest to the supervisor. But beyond that, I do not know any country in which the central bank is not very closely interested in the state of health of the banking system, irrespective of its supervisory responsibilities.
33. In my view, we should move as rapidly as possible to a model in which the present division of the geographical and functional jurisdiction between monetary policy and banking supervision plays no significant role. I do not mean necessarily a single authority or a single set of prudential rules. Rather I mean that the system of national supervisors needs to operate as effectively as a single authority when needed. While the causes of banking problems are often local or national, the propagation of problems may be area-wide. The banking industry is much more of a system than other financial institutions.
34. I am clearly aware that we are far from having a common supervisory system. But since the euro has just been launched and will last, we have to look in prospective terms at what needs to be set in place. There is no expectation, at least to my mind, that the division of responsibility in the euro area between the central bank and the banking supervisory functions should be abandoned. Although the Treaty has a provision that permits the assignment of supervisory tasks to the ECB, I personally do not rely on the assumption that this clause will be activated. What I perceive as absolutely necessary, however, is that co- operation among banking supervisors, which is largely voluntary but which finds no obstacles in the existing Directives or in the Treaty, will allow a sort of euro area collective supervisor to emerge that can act as effectively as if there were a single supervisor. This is desirable in the first instance to render the supervisory action more effective against the background of current and future challenges and, second, to assist the Eurosystem in the performance of its basic tasks.
TABLES
Table 1. Market share of branches and subsidiaries of foreign credit institutions as % of total domestic assets, 1997
From EEA countries From third countries
TOTAL
Branches Subsidiaries Branches Subsidiaries
AT 0.7 1.6 0.1 1.0
3.4
BE 9.0 19.2 6.9 1.2
36.3
DE 0.9 1.4 0.7 1.2
4.2
ES 4.8 3.4 1.6 1.9
11.7
FI 7.1 0 0 0
7.1
FR 2.5 NA 2.7 NA
9.8
IR 17.7 27.8 1.2 6.9
53.6
IT 3.6 1.7 1.4 0.1
6.8
NL 2.3 3.0 0.5 1.9
7.7
SE 1.3 0.1 0.1 0.2
1.7
UK 22.5 1.0 23.0 5.6
52.1
Source: ECB report "Possible effects of EMU on the EU banking systems in the medium to long term" (February 1999).
Table 2. Assets of branches and subsidiaries of domestic credit institutions in foreign countries as % of total domestic assets, 1997
In EEA countries In third countries
AT 2.6 NA 3.7 NA
NA
DE 12.0 7.3 7.8 0.9
27.9
ES 5.5 1.4 2.1 5.9
14.9
FI 5.9 0.3 6.6 0.3
13.1
FR 9.1 6.9 9.4 3.8
29.2
IR 8.3 14.9 1.3 10.1
34.6
IT 7.2 2.7 3.8 1.5
15.2
SE 7.2 NA 5.4 NA
Table 3. Concentration: Assets of the five biggest credit institutions as % of total assets
1985 1990 1997
AT 35.8 34.6 48.3
BE 48.0 48.0 57.0
DE NA 13.9 16.7
ES 38.1 34.9 43.6
FI 51.7 53.5 77.8
FR 46.0 42.5 40.3
IE 47.5 44.2 40.7
IT 20.9 19.1 24.6
NL 69.3 73.4 79.4
SE 60.2 70.02 89.7
UK NA NA 28.0
Table 4. Number of branches and subsidiaries of foreign credit institutions, 1997
From EEA countries From third countries TOTAL
AT 6 20 2 11
39
BE 25 16 15 15
71
DE 46 31 31 45
153
ES 33 21 20 6
80
FI 9 0 0 0
9
FR 46 118 43 98
305
IR 18 21 3 7
49
IT 36 4 17 4
61
NL 11 8 11 19
SE 14 0 3 1
18
UK 106 18 149 114
387
Table 5. Private non-financial enterprises' bonds, credit institutions' bonds and government bonds outstanding as % of GDP,
1997
Private Credit Government non-financial institutions' bonds bonds bonds
AT 2.7 31.1 30.6
BE 10.0 38.3 111.0
DE 0.1 54.6 37.6
ES 2.6 4.5 52.9
FI 3.7 7.1 35.5
IE 0.01 1.6 32.2
IT 1.6 19.4 100.4
NL NA 43.1 53.4
SE 3.6 38.6 46.5
Euro and European integration
Speech delivered by Eugenio Domingo Solans,
Member of the Governing Council and the Executive Board of the
European Central Bank, at the "Euro and Denmark" exhibition in Aalborg, Denmark, on 10 September 1999
INTRODUCTION
It is a real pleasure for me to participate in the "Euro and Denmark" exhibition in Aalborg. It is the first time since my appointment as a member of the Executive Board of the European Central Bank (ECB) in May 1998 that I have had the opportunity to speak in Denmark. Thank you for your invitation and for asking me to share my views on the euro and on European integration with investors and experts of this "pre-in" country.
I should like to refer to two main topics. First, and more extensively, allow me to explain the ECB's view and my own view on the role of the euro as an international currency. After this I intend to make some brief comments on the key role that the euro and the Eurosystem are playing in the process of European economic integration.
Before I begin, I should like to add that it goes without saying that the institutional position of the ECB - and therefore my own official position - concerning Denmark's entry to the euro area is one of strict neutrality. This is an issue which has to be decided by the Danish people, whenever and in whatever way they deem appropriate.
THE EURO AS AN INTERNATIONAL CURRENCY
The three basic functions of the euro
Every currency fulfils three functions: store of value, medium of exchange and unit of account. Concerning the first function (store of value), the euro is used and will increasingly be used as an investment and financing currency by market players, and as a reserve currency by public authorities. Regarding the second function of money (medium of exchange), the euro is used and will increasingly be used as a payment or vehicle currency for the exchange of goods and services and for currency exchange itself. It will also have an official use as an intervention currency. Finally, as regards the third function of any currency (unit of account), the euro is used and will increasingly be used by economic agents as a pricing or quotation currency and as a pegging currency by the authorities responsible for exchange rate issues.
Let me give you some information about the present use of the euro in each of these areas. I shall first refer to the private use of the euro, after which I shall consider its official public usage.
The euro as a store of value
The available information seems to confirm that the euro already plays a significant role as an investment and financing currency in international financial markets. Without going into precise details (1), regarding the international debt securities market (money market instruments, bills and bonds), it can be said that in the first two quarters of 1999 net international issues denominated in euro amounted to EUR 83.9 billion, compared with EUR 74 billion for the US dollar and EUR 50.9 billion for former euro area national currencies and ECUs during the same period of 1998. In other words, in the first two quarters of 1999 net international issues of debt securities denominated in euro were 13.4% higher than those denominated in US dollars, and 64.8% higher than those denominated in former euro area national currencies and ECUs issued during the same period of last year.
With regard to equity markets, the weight of euro area stock exchanges in terms of capitalisation ranks a clear second, far behind the United States.
As to the banking sector, the latest data show that, at the end DX :>48@>2:0 ?;5=:8T- -#"+ !-+ 1999DXCODE.HTof March 1999, above 40% of deposits and loans vis-а-vis non-residents were denominated in euro, with the share of the US dollar almost as high.
The euro as a medium of exchange
As for the second function of money (medium of exchange), the euro needs more time to develop as a payment currency for goods and services in international trade and as a vehicle currency in the foreign exchange markets. Although no precise data are available at this stage, the value of world exports denominated in euro is not likely to differ significantly from that of euro area exports. By contrast, the value of world exports settled in US dollars is nearly four times as high as that of US exports. This difference can easily be explained by the combined and reinforcing effects of network externalities and economies of scale in the use of a predominant international currency, as is the case with the US dollar.
The euro as a unit of account
The use of the euro as a unit of account (its third general function) is closely linked to its use for the other two main functions. The use of a currency as a unit of account is, in a way, the basis for its use as a store of value or as a medium of exchange. The value stored in euro, or the payments made in euro, will tend to be recorded in euro. Therefore, we can conclude that the euro is playing an ever larger role as a unit of account for all the financial assets linked to the use of the euro as an investment and financing currency, and has a much less relevant role as a standard for pricing goods and services, owing to the widespread use of the US dollar as a payment and vehicle currency in international trade. The convenience of using a single standard for pricing commodities in the international markets, allowing traders to make direct comparisons between prices, makes it difficult for the euro to acquire a significant role in this respect. We can conclude that the development of the euro as a unit of account will follow the pace at which the issuers or suppliers of assets, goods or services priced or quoted in euro obtain a predominant position in the international markets.
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