MEPs debate with Christine LAGARDE, President of the European Central Bank (ECB), the vulnerabilities in the EU's financial system and in January 2023 published a recommendation on vulnerabilities in the commercial real estate sector in the European Economic Area.

Brussels

public hearing

European Central Bank

monetary dialogue with the ECB (T)

Committee on Economic and Monetary Affairs

banking supervision (T)

LAGARDE, Christine (FR)

TINAGLI, Irene (S&D, IT)

Public Hearing with Christine Lagarde, Chair of the European Systemic Risk Board: introduction of Irene TINAGLI (S&D, IT) and opening statement by Christine LAGARDE, President of the European Central Bank (ECB)

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, Madame Chair, Irene. Honourable members of the Committee on Economic and Monetary Affairs. Good afternoon and it is a pleasure to address you in my capacity now in this hour of President of the European Systemic Risk Board, also known as the SRB. What I will try to do in my remarks is to set out macroprudential policy considerations for banks and non-bank financial intermediaries.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, As you know, the ECB issued a general warning on the vulnerabilities in the union's financial system back in September 2022. Since then, some economic developments have surprised to the upside. While some vulnerabilities identified in the warning have come to the fore. On the positive side, growth forecasts for 2023 have recently been revised upward from 0.5 to 1%, while downside risks to the short term economic growth have somewhat declined.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, Or the growth is expected to slow down this year. The EU economy has proven to be more resilient than expected in the face of the large negative terms of trade shock from Russia's war in Ukraine. But developments in banking and financial markets over the past few weeks emphasised the need to remain vigilant about vulnerabilities in a challenging macro financial environment.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, In this respect, I welcome the coordinated action by major central banks, including the ECB, to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangement. The ECB had identified in its September warning the following key risks to EU financial stability and indeed will continue to monitor such risks. First, in an environment of still subdued growth prospects and elevated inflation. Firms and households balance sheets could come under stress.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, Second, vulnerabilities in the non-bank financial sector could exacerbate volatility and asset price corrections. Third, the challenging macroeconomic outlook, coupled with elevated geopolitical tension, highlights the importance for banks of prudently managing their credit market and funding risks.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, Fourth, the risk of system wide cyber incidents remains severe amid heightened geopolitical tensions. Turning to the EU banking sector, it remains strong in terms of its aggregate capital and liquidity position. Capital is much higher than it was 15 years ago before the global financial crisis. With a common equity Tier one ratio of nearly 15% at the end of September.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, The liquidity position of the European banks is robust. If you look at the liquidity ratios on average, they are clearly above the minimum requirements and even the pre-pandemic levels. Even if you look at the composition of these liquidity buffers, the large part is cash and deposits with the central bank. The EU banking sector has benefited from the ongoing normalisation of interest rates.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, As the interest rate passed through on the asset side still significantly exceeds the pass through on the liability side. As a result, aggregate banking sector profitability has increased to its highest level since 2014. As the September warning stated, several factors continue to weigh on the outlook for banks. First, the perceptible deceleration in economic growth and higher interest rates may lead to a deterioration of asset quality.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, Second. Banks-Funding costs are rising, exerting pressure on interest margins. And third, banks are tightening lending standards over concerns about the worsening economic outlook and rising credit risks, which may weigh on lending volumes. The impact of these factors is expected to become more pronounced over time.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, Individual financial institutions should carefully preserve their current levels of resilience to ensure that they could weather a potentially less favourable environment. Let me now turn to risks related to financial market corrections. This is important as all financial institutions, including banks and non-banks, interact in financial markets.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, Such asset price corrections and heightened volatility could be exacerbated by vulnerabilities in the non-bank financial sector. In fact, there have been several episodes of market volatility in the last months that resulted in liquidity challenges for non-bank financial intermediaries. We are analysing such episodes with great care because vulnerabilities in non-bank financial intermediaries can result in pro-cyclical selling behaviour that would amplify asset prices falls.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, The ECB has repeatedly called for regulatory reforms in the non-bank financial sector. In particular, we flagged the need for a comprehensive set of tools to deal with systemic risks related to non-bank financial intermediaries. Both my predecessor and I have raised this point in your committee several times. And overall, little progress has been made so far.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, On the positive side, I very much welcome the position that this committee has taken on investment funds within the review of the Alternative Investment Fund Managers Directive and the Directive of undertakings for collective investments in transferable securities. Your stance reflects most of the SRB proposals and if co-legislators agree, it would help reduce systemic risk.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, Certain policy enhancements would still be needed, for example, to ensure better alignment of redemption terms and asset liquidity in open ended funds. This is at the centre of the work undertaken at the international level, at the FSB, the Financial Stability Board, as well as the SRB. At the same time, I would encourage you to help reduce systemic risk and increase resilience in other areas.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, First, in the Investment Fund universe, it is important for legislative reforms of money market funds to be implemented in the EU without delay. The ECB issued a recommendation which aims to strengthen the resilience of this sector without unduly restricting the economic functions that money market funds provide to other market participants in the real economy. We encourage the European Commission to act, and we hope that the European Parliament will contribute to the strengthening of this framework.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, Second, in central clearing. It is important to enhance the European Market infrastructure regulation within the ongoing targeted review. We are sending you a long letter with some macroprudential considerations to this end. This letter will actually go out later today, will be addressed to you, Madam Chair, and to and I'm sure that you will have a chance to share it with those interested.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, Last but not least, this Parliament should contribute to the strengthening of solvency two for insurers and not only in the area of liquidity risks. We have engaged with your committee on this matter as well. So let me conclude. Sound capital and liquidity positions and robust profitability are contributing to the resilience of the EU banking sector.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, But each and all financial institutions should carefully preserve the current levels of resilience to ensure that they could weather potentially less favourable environment. Moreover, thanks to the regulatory reforms implemented since the global financial crisis. Authorities have the macroprudential instruments at hand to build up resilience further, if and when needed.

SOUNDBITE (English), Christine LAGARDE, President of the European Central Bank, At the same time, persistent vulnerabilities in the non-bank sector mean that the regulatory and policy responses for this part of the financial system need to be accelerated. We call on you as the co-legislator to contribute to a robust macroprudential framework for this sector. Thank you very much and I will not take your questions.