From the “I will do whatever it takes and, believe me, it will be enough” of the former head of the European Central Bank (ECB), Mario Draghi, to the “I will monitor the side effects” of monetary policy of the current president, Christine Lagarde, considerable time has passed. Too many years of implementing expansionary monetary measures of a caliber unimaginable in the past, necessary to initially overcome the crisis. Now, however, they are beginning to be questioned, and the balance is increasingly tilting toward the risks versus the benefits of maintaining these measures.
The ECB’s latest financial stability report refers to the search for returns by investors in a low interest rate environment and warns of potential excesses in risk and solvency in the non-bank financial sector. It also warns about excessive corporate debt and the sustainability of public debt, and acknowledges that it is monitoring asset valuations in financial markets that are increasingly dependent on low official interest rates. All this without losing sight of the low profitability of private banks, especially when compared to the cost of capital. These are vulnerabilities for the financial sector—for banks and for companies that are not banks but provide banking services—that derive directly and indirectly from the excessive prominence that monetary policy has achieved.
The way out of this situation lies precisely in achieving a combination of policies that boost demand through fiscal measures and favor potential growth with structural reforms. This would relieve the current pressure on monetary policy, favor its gradual return to normality starting with the elimination of the most distorting measures, such as negative interest rates. This is not about shifting toward restrictive financial conditions, but rather about withdrawing the excess of accommodative monetary measures and thereby strengthening their efficiency.
Let us think for a moment about the interest rate curve, currently with a flat slope due to negative official interest rates and the continuous purchase of debt by the ECB in financial markets. Forward interest rates no longer reflect the expectations of economic agents, and the fact that more than 60% of medium- and long-term public debt is in negative territory is a source of uncertainty that can affect the final decision on any investment project. Not to mention the financial repression on savings, penalizing it precisely when we need society to become aware of the challenges facing public pension systems. European households, however, respond to this scenario by increasing deposits in private banks for reasons of trust, security, and even profitability. The safe alternative is short-term public paper with negative interest rates, that is, with a penalty. Banks are thus the barrier preventing negative official interest rates from being passed on to households. Finally, lower financing costs do not exactly favor discipline in public debt in the face of an increasingly foreseeable change of momentum in the economic cycle.
The financial stability report of the monetary authority acknowledges that European banks have improved their solvency, are regulated and supervised rigorously, and successfully pass the stress tests that are carried out periodically. But this does not prevent the possibility of approving new macroprudential measures on banks to combat the risks looming over the financial sector as a whole.
José Luis Martínez Campuzano, Spokesperson of the Spanish Banking Association
