Eesti Pank head: eurozone no longer in crisis

Photo: Sander lvest

Estonian central bank president Ardo Hansson says eurozone crisis is no more while we continually experience a difficult situation with growth outlook modest and fragile.

These past years, my first question to people in finances and banking has been whether the European debt crisis is over. Are the debt crisis and the global finance crises over?

I think it would be too much to be talking about crisis right now. In Euro area, at least, we see no crisis at the time. What we do see is lots and lots of problems. Of these, some are rather serious – how to boost economic growth and how to enhance confidence. But do these problems measure up to be a crisis, I’m not quite sure.

How, then, would we call this situation?

A difficult period, with growth outlook comparatively modest, uneven and a bit fragile.

Why have the current measures failed to enhance the economy? For three years already, the central bank has been offering liquidity. For more than two years, there is no talk of the eurozone breaking apart, but the so-called real economy has not been affected by these measures. Why?

The situation is expressed in very low investments. Consumption growth is rather normal, export outlook is not too bad. The weakest component is investments.

Partly, this is because Europe still has unused production capacity. The companies are saying: why invest if part of the machines are idle.

Another reason is confidence, something that is difficult to define but clearly noticed. As long as external or domestic demand will not show a growth more persistent, many entrepreneurs say let’s wait some more. Quite many enterprises are sitting on big cash accounts; they have lots of money but they are not investing.

If somehow, via reforms, we would be able to infuse positive emotion in entrepreneurs also, giving them new energy, than that might help.

Am I right in saying that November may be called the birth of European banking union? What changed, and what is yet to change?

A birth in the sense that the first stage is passed – on November 4^th, European joint banking supervision was launched. The banking union does include other dimensions which are in formation stage still. Firstly, the rules for reorganisation and restructuring of banking are still being developed and to a degree it is clear that, in the future, we might advance with reorganisation of deposit insurance system.

In the initial phase, 120 banks are now under direct European Central Bank (ECB) supervision. For us, these are two banks, Swedbank and SEB; the other banks [in Estonia] are under local supervision, but according to uniform rules.

As the central bank functions have expanded, isn’t there a danger that ECB will become an institution too strong? To this day, it is only Mr Draghi (ECB president Mario Draghi – edit) that is talked about in the context of fighting the debt crisis, and now he gets extra powers yet.

Every solution has its strengths and weaknesses. This solution was only chosen for it being in accordance with the fundamental treaties of the European Union. The underlying treaty prescribed that ECB might have such a capacity. Had such a solution not been used, the common European banking supervision would never have been born. Every other agreement would have necessitated revision of the foundational treaties.

Perhaps some synergy is created by the central bank doing the supervision, but there may also arise conflicts of interests and, as you are saying, a whole lot is happening on one institution. 

To prevent conflict of interests, it has been attempted to put a clear difference between the two parts i.e. monetary policy and supervision. Within the institution, a so-called Chinese Wall has been erected (information barriers guaranteeing independence of decisions – edit) and the reporting verticals have been separated very strongly.

How much extra load will that mean for Eesti Pank, or will the burden mainly fall on [Estonia’s] Financial Supervision Authority?

The main load will indeed be on Financial Supervision Authority. We will be participating as the final decision-making body is ECB council where I am a member. The decisions are made in the so-called supervision committee, but they will be accepted at the council – therefore, being a participator, I will need to form an opinion about the situation in banks in other countries. That requires some background analysis.

In real life, it means rather many extra jobs at Financial Supervision Authority. We are not affected to that degree.

So you will not have to hire extra staff?

We will employ new staff in the area of financial stability as we have been given new tasks domestically, first and foremost. Riigikogu assigned us the role of macro-financial supervision, and therefore or work load grows. Thus far, we have tried to solve that by increasing effectiveness.

What is the essence of macro-financial supervision?

Before the crisis, we were looking at macro-economic policy which is monetary policy, budget policy etc. Supervision, however, was bank by bank. What went unnoticed, however, was that a bank may have been relatively strong, but should some problem erupt someplace else, that might spread into the broader financial sector.

This is the direction which has been created in Europe and the whole world – to create complementary instruments in order to stand against systemic risks. These systems may be both cyclical risks and structural risks. For instance, some banks may be too big; in that case, perhaps, they need additional capital requirements imposed.

Bank executives are complaining that regulation has grown too big and it is already beginning to impact product prices.

There may indeed be a pendulum effect. Beholding the lessons of the crisis, there was under-reaction; now we are trying to correct the mistakes and in the outcome we are complementing the regulation. There is a strength to this, but is naturally comes with a price.

It is not easy for the banks to keep the regulations, but I do think sometimes these rules are also imposed because the banks (I’m not speaking about Estonia) are also fighting reasonable regulations. If you are always fighting any regulation, then in the end you may get a solution that isn’t ideal.

What about the health of our banks? Glancing at capital adequacy and size of profits, it seems almost too good.

Just some months ago, we published the financial stability report, saying the risks are relatively low currently. We see the banks have a very strong capital base. The loans/deposits ratio is positive in the sense that in the boom times the banks were financing out of foreign sources, but now it’s more or less out of domestic deposits. The percentage of bad loans is comparatively low. According to very many indicators, it seems the situation is rather good.

Profitability is quite good as well. This can be viewed two ways. On the one hand, one is glad that thanks to the profits the banks are able to create their buffers. Even so, if they are very profitable, it suggests that product prices might be lower.

There are the risks. On the one hand, the risks are related to the vulnerability of Estonian economy – the economy in many ways is dependent on export and should something go wrong there, the health of banks may be affected. The other risk is related to the Nordic real estate sector and the broader Nordic economy. There, the real estate prices have grown quite nicely, especially in Sweden, and should their prices start moving in the other direction, it may backfire and affect the behaviour of these same banks in Estonia.

And the third risk is related to the Estonian real estate market. Half a year ago we were able to say Estonia had the fastest real estate price rise in Europe, and we consoled ourselves by the banks not heating it up. Recently, we see it as positive that real estate market development has stabilised and, in our opinion, the risk level there has come down a bit.

How large are the risks, considering that the bank buffers are very big, the profits are very bog and the banks are already paying dividends?

The risks are not such as would lead banks to very difficult situations, but they breed cyclicalness. We would desire to avoid a situation where we have a couple of years of boom, and then a couple of years of tremendous drop. Maybe it would be better to avoid such periods of euphoria which obviously aren’t sustainable and which do backfire.

Back to European Central Bank. I have gotten the idea you are one of the members at the council who are against massive government bond purchases.

I have expressed scepticism regarding these programs and I do have quite a lot of questions about them. We all agree that inflation is low currently and if there’s the danger of it remaining low for a longer period of time, all have the readiness to apply additional measures. In that, we have no disagreements. But when it comes to what exactly do we do, every option has its strengths and weaknesses and I think that, looking at the same thing, different people may come to different conclusions.

What is questionable, there?

One is the issue of effectiveness. With interest rates ultra low, at least with government bonds, the question arises how much effect is there to be achieved? The other issue is related to financial stability. If the measure proves to be effective and we drive interest rates even lower, what will become of the economy when at a certain moment the interests again start to rise (and sometime this will happen anyway)? The third issue is: EU basic treaties include the ban on financing governments which means the central banks is not to finance governments. It has very clearly been stated that, direct financing is forbidden i.e. if a state emits new bonds the central bank may not directly purchase these. It is also the matter of the spirit of the provision. If we see that such a purchase program starts to boost a deficit in some state, then we come close to the line where we also need to face the restrictions arising from foundational treaties.

Meanwhile, we have to admit there are the risks related to taking actions, and there are also the risks in taking no action. Currently, it is hard to imagine risk-free action.

Three thoughts:

At least in eurozone we see no crisis currently. What we do see is very many problems.

120 banks are now under direct ECB supervision. In Estonia, there are two – Swedbank and SEB.

We would like to avoid a situation of a couple of boom years followed by a couple of years of tremendous drop.