1. Frank Moss (European Central Bank) Athens, 18 May 2012
3rd Bank of Greece Workshop The Euro Area Sovereign Debt Crisis and Its Implications for the Economies of SEE The implications for the financial sector and ECB policy initiatives to alleviate the consequences of the crisis
Frank Moss (European Central Bank)
Athens, 18 May 2012

2. The vicious cycle between fiscal/banking/growth developments
A shock to the fiscal outlook
Will add to financial volatility/increased interest rates in the sovereign debt market
Will reduce the foreign investor base for sovereign debt (and increase the sovereign CDS)
Will necessitate more domestic bank funding for the sovereign
Will reduce the appetite for wholesale investors in bank debt (and increase bank CDS)
Will lead to higher bank funding costs and a reduction in access to interbank markets
Will reduce the capacity for banks to extend credit
Will reduce economic growth
Will create a new shock to the fiscal outlook and will increase the NPLs for banks 2 2

3. The ECB’s crisis response – non-standard monetary policy action to address malfunctioning financial market segments
Bank funding
Fixed-rate full allotment mode in all refinancing operations (since October 2008)
Lengthening the maturity of the refinancing operations (1, 3, 6, 12 and 36 months)
Extending the list of eligible collateral (and not fully relying on rating agencies)
Extending liquidity directly in foreign currencies (USD and CHF)
Reducing reserve requirements
Covered bond market
Covered Bond Purchase Programme 1 (CBPP1) EUR 60 bn purchased from July July 2010; CBPP 2 under way for EUR 40 bn (until November 2012)
Sovereign bond market
Securities Markets Programme (launched in May 2010); EUR 241 bn purchased so far (but no QE !) 2 3

4. The 2 VLTROs made a distinct improvement in banks’ funding conditions
Euribor-OIS spread and the EUR/USD basis swap (Jan – Mar in basis points
Historical volatility of DE, FR, IT and ES 10-year government bond prices (1 June 2011 – 16 April in ppt.) 3 4

5. … and had a beneficial effect on sovereigns, even outside the euro area

6. Using the window of opportunity to address the real challenges
Repairing the banking sector
Adequately provisioning for the sovereign risk exposures (EBA exercise)
Capitalising the banks adequately (Basel III)
Orderly deleveraging (national supervisors and ESRB)
Addressing the fiscal consolidation needs
Reinforcing the euro area fiscal frameworks
Enhancing fiscal sustainability through growth-promoting structural reforms
Strengthening the euro area/international financial support channels

7. Bank deleveraging as a medium-term global trend
Return to more sustainable business models is a global trend which can contribute to financial stability
less reliance on volatile funding sources
lower leverage
Euro area banks may need earlier and more deleveraging than their international peers
Comparatively high leverage ratios
High reliance on wholesale funding
Regulatory changes requiring larger capital and liquidity buffers (EBA re-capitalisation exercise, Basel III)
On-going subdued economic activity

8. Cross-border deleveraging in SEE countries
Concern about ‘home bias’ of euro area banks
Mitigating factors
Geographic proximity
Prospect of EU accession and euro adoption
Relatively bright medium-term growth prospects (catching-up)
Banks mainly funded by local deposits
Risk factors
Lack of economic growth in some countries
External and internal imbalances
Pockets of financial sector weaknesses
Volatile political environment in some countries

9. SEE countries mainly funded by local deposits

10. No firm evidence of ‘home bias’ during crises periods

11. Policy Initiatives aimed at mitigating cross-border deleveraging risks
European Banking Authority (EBA)
Assessment of deleveraging plans in the EU
Co-ordination of cross-border discussions in the Supervisory colleges
European Systemic Risk Board (ESRB)
Focus on systemic risk dimension of deleveraging at the level of the EU
Vienna 2.0 Initiative
Joint public/private initiative including non-EU countries in Central, Eastern and Southeast Europe

12. No dramatic recent cross-border deleveraging …
Change in bank liabilities
(Contributions to change in total bank liabilities in percentage points)
Q versus Q3 2008
Q versus Q3 2011
Sources: National authorities, Haver Analytics and ECB calculations.
Notes: Data for Montenegro refer to Q in the left panel chart as no data for Q (and thus for the right panel) are available.

13. Domestic deleveraging in some countries due to unsustainable lending booms

14. Summary and conclusions
A process of disorderly deleveraging by euro area banks was avoided through the ECB’s VLTROs and other policy measures
Especially European (but also other globally active) banks have good reasons to orderly deleverage over the medium-term
Weak credit growth in some countries may reflect demand factors at least as much as supply constraints
The SEE financial sectors should be increasingly based on local savings (‘new growth model’)
SEE countries face similar challenges as the euro area to maintain conditions for sustainable growth of which a sound financial sector is part