Claudia Buch has been the vice president of Germany's central bank, the Bundesbank, since May of last year. An economist by training and a former advisor to the German government, Ms. Buch is now in charge of financial markets stability. In an interview with Handelsblatt's sister-publication, the business weekly WirtschaftsWoche, she warned that a failure to reach a quick deal with Greece risks undermining confidence in Europe.
WirtschaftsWoche: Ms. Buch, how much of a risk will the resurgent crisis in Greece be to the European financial system?
Claudia Buch: The danger of direct contagion is less than it was just a couple of years ago since foreign banks have sharply reduced their exposure to Greek borrowers. The financial system is now more crisis-proof, too – especially thanks to better capitalisation and new institutions such as the European Stability Mechanism (ESM). But still, contagion effects are naturally impossible to rule out altogether.
What do you mean by that?
Contagion can also spread through the confidence channel. This is why it is important to reduce uncertainty and quickly gain a clear picture of the path of reform that lies ahead of Greece.
If Greece’s acute liquidity crisis poses a threat to the financial system, wouldn’t a haircut be a good idea?
Greece has already had its debt restructured and benefited from debt relief. The country’s problems are primarily of a structural nature and require a clear commitment to reforms. However, the debate on haircuts is creating added uncertainty. That is why I find it unhelpful.
Will the European Central Bank (ECB) rush to the rescue of Greek banks with emergency loans?
At its last meeting, the Governing Council of the ECB decided to lift the waiver affecting Greek government bonds as of 11 February. These bonds will therefore no longer be eligible as collateral for regular monetary policy operations. However, Greek banks will retain access to central bank liquidity; their counterparty status is unchanged. Should banks not have sufficient regular collateral at their disposal, their additional liquidity needs can be covered by emergency liquidity assistance (ELA) through the Bank of Greece. This is governed by clear rules, however.
What is the Bundesbank doing about this crisis in its role as guardian of financial stability in Germany?
We are monitoring the situation in the financial sector very closely. The banking union and the Single Supervisory Mechanism (SSM), too, are enabling us to better detect risk. If banks encounter distress, we now have a broader range of options to restructure them or, if necessary, resolve them. The framework has been created by the Single Resolution Mechanism (SRM).
But the SRM, the European “graveyard of banks”, will not be up and running until January 2016. What will happen if banks run into distress and go bust beforehand?
The idea behind the SRM is to involve the private sector in potential losses in the banking sector to a greater extent than before. In the past, the taxpayer often “picked up the tab” because nobody wanted to, or was able to, take the risk of a bank going bust. This ought to change in future. There is a clear liability cascade for losses, headed by shareholders and creditors. Many of the rules are already in force, though the proof will be in the pudding, of course. It will be important to bail in the private sector as widely as possible.
While this is happening, the ECB’s ultra-loose monetary policy is working up banks’ and investors’ appetite for risk because safe investments are hardly yielding any returns at all. A further source of risk?
The low interest rates reflect the expansionary monetary policy but also the sluggish economic growth in Europe. This kind of setting might encourage market players to take their eye off risks in their “search for yield”. Their resilience is therefore key. If losses occur, investors need to have enough capital to bear these losses without any outside help.
Will the ECB’s controversial bond purchases lead to an escalation of risky behaviour among banks and investors?
The program has only just started, so its impact is hard to pinpoint right now. What we do know from past experience, however, is that expansionary monetary policy and interest rates which remain very low for a long time can lead to riskier investment behaviour. And you could say that this is the very purpose of government bond purchases: to get banks and other investors to invest in riskier assets such as corporate loans, corporate bonds or stocks. The idea is to facilitate the financing of the real economy.
Are banks going overboard with building loans given the real estate boom triggered, among other things, by monetary policy?
Our data does not show a particularly strong pick-up in real estate lending, and there’s barely any sign of credit standards being loosened. However, some banks could very well encounter structural problems if real estate prices were to fall. That’s something we’re watching very closely. In addition, we are working on improving our data set even further. The European credit register which is currently being set up will help us in future to obtain better and more comprehensive information on real estate lending.
And what is the state of overall lending in Germany?
There are no indications that firms are constrained in their funding. Credit volume – relative to annual economic output – is significantly higher than it was in the 1970s, say. This holds not just for Germany but for other countries in Europe as well. One way of interpreting this is that the financial sector is better developed. However, a highly leveraged financial system can also be more vulnerable to shocks. That’s why one of our goals should also be to eradicate existing barriers to the development and integration of the European equity markets.
So is the German economy overleveraged?
That would be too much of a sweeping statement. On the whole, German firms have deleveraged and strengthened their capital base. Banks have also increased their capital. However, German banks are feeling the effects of weak earnings. We have to see to it that they are adequately equipped to cope with adverse economic developments.
Banks are complaining about overregulation. Is the idea of separating investment banking from lending business a step too far?
It is important for banks to hold adequate capital to protect themselves from the risks of all their business. I am not convinced that there is a simple rule by which “good” and “bad” banking can be separated.
Stricter rules for banks are causing many monetary transactions to migrate to unsupervised segments of the financial market.
This threat does exist. Which is why there are comprehensive initiatives to better observe and document the evasive actions being taken. I’m mainly referring to what are known as “shadow banks” – financial institutions which conduct bank-like business but are not regulated as such. In principle, these institutions need to be subject to the same rules as banks if they conduct the same type of business.
Should banks and insurers count their government bonds as risk assets?
Regulation usually does not require sovereign exposures to be backed by capital; where it does, the capital requirements are less strict than they are for claims against other borrowers. The large exposure limits are inconsistent, too. Over the medium term, we need to abolish this preferential regulatory treatment of government bonds as it ultimately biases investment decisions. The crisis has shown just how difficult it can be to disentangle the nexus between sovereigns’ and banks’ risks.
Could the much-discussed financial transaction tax make the markets safer?
In my opinion, the financial transaction tax does not address the root causes of the crisis. The objective must be to set the right incentives and strengthen the capital base. However, the financial transaction tax might end up having the exact opposite effect since it would also be applied to stock market transactions.
This interview originally appeared in WirtschaftsWoche. To contact the author: [email protected]