Family ties: ten years of monetary policy and banking supervision under one European roof

It has been 10 years since Single Supervision Mechanism (SSM) ws enacted in Europe.

Frank Elderson, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB in this speech revisits history:

The SSM was born out of crisis. In the years leading up to the establishment of European banking supervision, the euro area economy was struggling to recover from the great financial crisis and the euro area debt crisis. Financial crises and financial fragilities led to de-risking and deleveraging, which had negative repercussions on economic growth and the inflation outlook. Back then, weaknesses in the banking sector hindered the transmission of our accommodative monetary policy into similarly favourable financing conditions for companies and citizens. These obstructions to the transmission mechanism made it much more difficult for the ECB to maintain price stability.

Ultimately, the persistent weaknesses in the European banking sector led governments to establish the banking union. In addition to European banking supervision through the SSM, with a central role for the ECB, the banking union would include a Single Resolution Mechanism and a European deposit insurance scheme, although this third pillar is yet to be implemented. One of European banking supervision’s achievements has been the strong culture of cooperation within our pan-European joint supervisory teams, who use a harmonised supervisory methodology that ensures the same standards are applied across all supervised banks. This has helped to significantly reduce risks in the European banking sector and increase the resilience of European banks.

The efforts of European banking supervision have paid off. This became clear during the pandemic, which was the first major crisis since the creation of the banking union. Instead of being sources or amplifiers of shocks like in previous crises, banks proved to be resilient to the pandemic shock. In fact, they were able to help dampen it by extending credit to citizens and companies that had experienced a sudden loss of income. Unlike during the crises that predated the banking union, banks were no longer part of to the problem, but part of the solution. Of course, it should be kept in mind that they were able to do so in a context of massive fiscal support to citizens and companies and accommodative monetary policy.

Path going forward:

First, our objectives will become even more important. Price stability and sound banks provide an anchor that makes an economy – and therefore a society – more resilient to shocks. The more frequent and intensive the shocks, the more vital a secure anchor. For it is in choppy, not calm, waters when a ship truly benefits from its anchor.

At the same time, the types of shock hitting the economy and the financial system will become more complex to assess. But an accurate assessment is crucial to gauging the potential risk to price stability or to the soundness of banks, as well as the appropriate policy response.

Take the example of the ongoing and worsening climate and nature crises. We know that manifestations of physical risk – like floods, fires, droughts and extreme weather events – are on the rise. Governments are acting to support the green transition, while pursuing climate adaptation measures is becoming ever more important. A relevant question is whether climate and nature shocks can be fully captured by the traditional categorisation of demand, supply and financial shocks used in most macroeconomic models. In that vein, my fellow ECB Executive Board member Isabel Schnabel has suggested thinking about the impact of climate change on inflation in terms of “climateflation”, “fossilflation” and “greenflation”.^[1] Even if such concepts can be mapped analytically into the more traditional type of shocks, we need to learn more about the exact mechanisms before being able to draw the appropriate conclusions for monetary policy.

Something similar applies on the banking supervision side. The Basel Committee on Banking Supervision has established that climate-related risks translate into the traditional types of risk that banks consider^[2], covering credit risk, liquidity risk, market risk and operational risk, including litigation risk.^[3] However, here too, the exact mechanisms of mapping actual hazards to risks needs to be analysed further to fully capture climate and nature-related factors in quantifiable regulatory and supervisory requirements.

These are vitally important questions as global heating, nature degradation and transition and adaptation policies have a profound impact on the economy and the financial system. As Supervisory Board Chair Claudia Buch underlined in her opening address, research has an important role to play in supporting monetary policy and supervision in respect of these and other major challenges like the impact of geopolitical risks and the digital transition.^[4]

Some of these themes will feature at this conference tomorrow. And on the monetary policy side, we recently established a new research network known as Challenges for Monetary Policy Transmission in a Changing World (ChaMP). The ChaMP network seeks to revisit our knowledge of monetary transmission channels in the context of unprecedented shocks and structural changes.^[5] Through conferences such as this one, initiatives like the ChaMP network, and many other interactions with the research community, we seek your inspiration, ideas and insights to address the challenges facing monetary policy and banking supervision in the future.