Published on 22 June 2016
An edited transcript of the interview
Britain may decide to leave the EU. What would be the economic and financial impact of this decision?
I have learnt early never to reply to hypothetical questions. I can only say that we hope that the UK stays in the EU. It is in the interest of the EU and of the UK. Referenda are always for the voters to decide, from the outside you can’t do or say much.
What is the ECB doing to prepare for a possible “Leave” vote?
Of course we must always be ready for everything, but for now all I can say is that I hope they stay inside.
Moving on to monetary policy, the quantitative easing programme is set to end in March, unless you decide to extend it. Will you back an extension?
We must look at monetary policy as a package of measures. Our aim is price stability, defined as inflation close but below 2% in the medium term. This target is symmetric. The challenge is that when inflation is very low, the instruments are not symmetric because you have the zero-lower bound. In this context we must look at three things: monetary policy instruments, including traditional ones such as interest rates and non-traditional ones such as negative deposit rates; second, forward guidance which postpones the expected tightening of monetary policy; and thirdly the large-scale asset purchases that pull the yield curve downwards. These three measures are all helping to achieve the target of price stability and support the economy.
We have done so much, so far, and we are just starting to implement two important parts of the package: to buy corporate bonds and to conduct the second series of targeted longer-term refinancing operation.
We just need to implement these with steady hand. I am convinced that we will deliver.
What’s your assessment of the European recovery?
In general, the euro area economy has been recovering, and the recovery has been broad-based. Somehow, this is sometimes forgotten. Even in my country, Finland, people focus on issues such as Greece and don’t see that this recovery has already continued for some time and that monetary policy is keeping its force.
Of course, our concern is a prolonged, too low inflation. Therefore we need to implement our programmes with a steady hand. This is a marathon, not a sprint.
Do you think we are at a floor for interest rates?
We have carefully formulated our forward guidance, that rates will remain at the present or lower level for an extended period of time, and well past the horizon of our net asset purchases. There is no need to change our forward guidance: it has served us well and gives a framework for our measures.
The corporate bond purchases is a big step. There are criticisms that you are distorting the corporate bond market by choosing one company over another. How do you respond to that?
When we started to discuss the large-scale asset purchases, experts in the Bank of Finland proposed to have corporate bonds on the agenda. We have been investing in corporate bonds for decades and are now one of the six banks that are implementing the programme.
Corporate bonds enable us to strengthen the pass-through of our monetary policy to the financing conditions of the corporates and to enlarge the universe of the purchases. There are also countries in the euro area where the sovereign bond market is very limited. We purchase corporate bonds that have an investment grade rating.
There is always criticism, but all in all, I believe we have been very consistent with the implementation of the asset purchase programme.
Moving on to banks, in Italy there has been widespread criticism of the bail-in mechanism which some, including the Bank of Italy, say increase financial instability. Are you concerned about this issue?
If we have learnt something from the crisis, it is that this asymmetry in the market, where profits are private and losses are to the taxpayers, does not work in the long-term. I am sure that this fundamental idea is still the right one. Of course, when you move from one stage to another, there can be difficulties and there can be criticism. Even in my country it is the same. It is very important that banks inform the citizens so that when they buy securities they know what risks are involved there. It is very important investors know there are implications.
Critics say you are treating banks as cheese shops, assuming you can easily close one and go and buy cheese from a different one. But banks are different and there can be systemic implications from applying bail-in to some investors. How do you respond?
In the long-term the clarity of business environment and regulation is very important. For me the legislation has been an important step in the banking union. First, we have created a single supervisor for over 130 banks and we are introducing coherence in the supervisory practices. This is going pretty well. The second part has been the recovery and resolution framework.
When you make such a substantial reform it is important to keep in mind the long-term goal: profits and losses would be shared by the same stakeholders.
I am aware the transition can cause problems for smaller banks. For big banks, we have one supervisor, looking at them in a coherent manner. But we also have thousands of small banks, and we need to adopt the same culture, both for supervisors and the banks. But this takes time.
Some economists, including the Governor of the Bank of Italy Ignazio Visco, say we need a backstop at the European and national level to avoid a crisis from getting out of hand. Do you think they are right?
In the transition period, some assistance can be justified, but you should not replace the idea of bail-in with common funds. If we talk about a solution like insurance, which means risk-sharing, there is a case for creating a common deposit insurance scheme over the long-term. Once we get all the banks on the same footing, so they are properly capitalized, they are in the same position, of course this type of risk-sharing scheme makes sense.
Sometimes the risk is that people just want to focus on the backstop and forget everything else.
So you think banks should be in the same position before you have a joint deposit guarantee scheme?
Ecofin said in the conclusions: “Negotiations at the political level will start as soon as sufficient progress has been made on the risk reduction”. This seems to be now the political framework.
Before you take the final step, banks should be in the same position. I support the logic that in the end this kind of insurance-based, risk-sharing is justified and important. You must move in parallel in all these areas.
In your 2012 report you recommended separating the trading activity of banks from retail activities. What was the logic behind that?
The logic is simple. Bank funding typically benefits from an implicit government guarantee, which is based on the deposit insurance. If this guarantee is also behind high-risk activities, such as proprietary trading or other large-scale market-making activities, this can lead to excessive risk-taking.
A lot has happened in the markets since we published the report, as we have seen that many of the banks that had very large portfolios in this trading side have downsized them. Our proposal was not for this financial cycle, but for the long term: you can have commercial and trading activities in the same company, but they must be separated, so that market-making and proprietary trading are financed properly on the markets.
The proposal is now sitting in the European Parliament, and we will see what happens.
Do you have a sense of when they will decide on it?
Of course I talk to them, but there are many other important issues on their table at the moment. It is up to them to decide.
You also recommended banks should have sufficient bail-inable debt and a clear hierarchy of instruments to be used in bank resolution. There is a discussion going on about the so-called TLAC – a buffer banks should have to spare taxpayers in case they are resolved. Some countries, including France and Italy, are saying that the Single Resolution Board is asking too much from the banks. Where do you stand?
I understand one preoccupation of the banks. There has been a long process of reforms, changes, which have been pretty heavy, particularly for the smaller banks, who don’t have the corporate services to run these all the times. We should be able to get to a new position, where we can say, that’s it for now, then we take a pause. This does not mean we are done forever, but take a pause. I think the time when this pause would be justified is coming close.
I often talk to banks, including small- and medium-sized ones, so I appreciate their concerns. However, the banking lobbies often make one mistake: if they lobby against everything, this weakens their position. But I understand well that at some point they need to know that now we consolidate the reforms, take a pause, so that they can develop their business model, concentrate on that.
From the reforms we have passed we can say that the banks are more stable, they are better-capitalised, but in the medium term they must be also profitable. Profits are important for the stability of the banking system, as banks must be able to finance capital losses, which can come from lending and risk-taking. This issue of long-term profitability is there and I don’t contest it.
Do you think the capital position of European banks is strong enough at the moment?
It has improved. The comprehensive assessment of 130 banks was very important. It has not been contested. There were some very good aspects: for example, it was conducted at the European level, so there was no national regulatory capture. People had to treat banks equally and they did not have any bias. So it has been more credible and the recapitalization was very important. Often banks have used retained profits for recapitalization, this has made banks stronger, better-capitalised, more transparent. Of course, there are still a few pending issues, one is of course non-performing loans. If banks have a major problem with NPLs, their capacity to lend is more limited. This whole question of NPLs includes many questions: what kind of legal procedures you should have in case of bankruptcy, accounting rules, what kind of vehicles you create for handling NPLs. At the end of the day, of course, you need to have capital to finance them. These are the issues that remains on the table and it is important for the European banking system and national supervisors to deal with them.
Italian banks have a substantial problem with NPLs. Policy-makers in Rome complain that Europan supervisors are obsessing about NPLs, while caring less about other issues, including trading losses, for example on derivatives. Do you agree with this concern?
If one does an analysis of how the lending is related to the level of NPLs there is a correlation: the more NPLs you have, the slower your lending grows. So for banks to deliver their task of lending, it is important they downsize their NPLs.
But of course, my working group in the report was proposing changes to banks’ trading activity. So we should not forget any risks. I know it is not a quick fix, but the banks’ capacity to lend is dependent on not having a too high burden of NPLs. Everyone is entitled to his own opinion, but we should have the same facts.
Are you concerned that the ECB’s hyper-active monetary policy may be contributing to financial instability?
ECB Governing Council has been consistent: if you study our communication since December 2014, we have always linked asset purchases and forward guidance together. It has been very coherent, from meeting to meeting. Forward guidance stays there and you reinforce it with particular measures. It is not hyper-active, but it is active, because the situation has been very difficult. And monetary policy is working.
If you look at the European recovery, it is clear that monetary policy has played its role. The transmission channels are many, but in a marathon you should not stop half-way, you need to keep the tempo and patience, and deliver. Also, the Governing Council has shown its capacity to act and communicated in a coherent and consistent manner.
In these difficult times there has been an institution that is strong in its commitment and consistent in its actions. We have delivered, but the ECB can’t do everything. That’s of course the big issue of structural reforms: we often talk about them in a too general manner, but they are needed to create dynamism in the economy, improve competitiveness, so that companies can have trust in the future and can decide to invest. It is important to create the willingness from companies to move on, since the financing problems are more limited than they were before. And companies should also do their part.
Are you afraid that Brexit could derail the European recovery?
There is one issue of which I am sure: for Finland, the EU has been the right choice. We have been able to join a Union where the relations between States are based on law, not on force. This has been the case for us since 1995.
We will not give away this choice, since it is critical for our country. If you look at the challenges we have around, we would be much weaker if we were to act all alone, we would be in a much worse position. In the political area, I am convinced there is a very broad European attitude in favour of this choice of the EU, when we take into account our history. I have seen the speeches by David Cameron and Gordon Brown making these points, presenting the case in a way we can share. We have these populist tendencies which come and go, but would we really like to turn back? What would be the alternative? We don’t know what will happen with Brexit, but our cause remains the same.