Category: Interviews

Europe is currently facing greater challenges than back in 2011/12 when the euro zone was one step away from falling apart. Back then, the ECB saved the day, and the crisis ultimately was overcome.

Ignazio Angeloni, one of Europe’s foremost banking and supervisory experts, discusses some of the challenges European fiscal and monetary policy is facing in the aftermath of the crisis with Beat Siegenthaler of the UBS Knowledge Network.

Transcript

Q&A with Ignazio Angeloni, former ECB Supervisory Board Member

There is no problem for sovereigns to finance themselves, and no immediate concerns including for Italy which keeps tapping markets at sustainable cost, says Ignazio Angeloni, former member of the ECB Supervisory Board. In his view, debt sustainability problems may arise though in the second phase of the crisis, which could begin mid-2021 or so. There is also a fundamental issue with bank profitability and bank viability in Europe which predates the crisis and will have to be addressed. Ignazio Angeloni is one of the continent’s foremost banking and supervisory experts, having been at the ECB in various positions as well as at the Italian Ministry of Economy and Finance as its Director of International Financial Relations. He is currently a Senior Fellow at the Harvard Kennedy School.

Ignazio Angeloni spoke to Beat Siegenthaler of the UBS Knowledge Network from Frankfurt on 5 May 2020.

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Beat Siegenthaler: What is your initial take on the German Constitutional Court ruling on the ECB’s PSPP?

Ignazio Angeloni: Well, I’m not a lawyer, and this is a complex ruling which will have to be pondered very carefully [see here for a note discussing the ruling published after this interview took place]. I was positively surprised by the fact that there’s no allegation of monetary financing, and that the court also discards the possibility of improper transfer across countries. The judges focused on proportionality. They want to see more clearly demonstrated that the instrument used was necessary for achieving the purpose, which is price stability, the ECB’s objective. They ask the ECB, within three months, to demonstrate that what has been done was necessary for that purpose.

I was rather shocked to see the court seemingly implying that price stability is not unconditional but its benefits have to be weighed against other implications, other effects of the instruments used. We were always told, from the German side, that price stability should be number one, to be pursued regardless of everything else.

BS: The market reaction right after the publication of the ruling was relatively muted. Are you concerned that the ruling could undermine the credibility of the PEPP, and make life more difficult for the ECB?

IA: A bit of additional uncertainty is undeniable. Italian spreads were up, though very moderately. It will depend on how the ECB will react. I think that any arguments made for the PSPP will also hold for the PEPP. But I’m relatively relaxed. We have to see what the ECB comes up with.

During the period of time we are now living through, OMT is not the appropriate instrument as it is designed for individual countries losing market access, and requires conditionality. At the moment there is no problem for the financing of sovereigns. There is no immediate concern for the Italian Treasury for example. I think potential problems for public debt sustainability may come in the second phase, at the beginning or at mid-next year.

‘We were always told, from the German side, that price stability should be number one, to be pursued regardless of everything else’

BS: So you would say that the ECB has the right instruments to address the crisis?

IA: The ECB has chosen to act in installment, in a sequence of steps. They started at the beginning of March with some liquidity measures, which were clearly insufficient; but then came the PEPP. Following that they took, in two stages, measures to enlarge the collateral framework and then introduced additional liquidity measures for the banks – the PELTRO. One should see this as a whole set of measure, one single policy.

It’s fair to say that they’ve shown flexibility and promptness to adjust to the evolving situation and to incoming information. There’s still a lot of uncertainty, big range of possible outcomes. The ECB is proceeding incrementally, following the information as it becomes available. The ECB has been criticized in the past for being behind the curve. I don’t think that’s the case now. They are not behind the curve, nor ahead of the curve; they are right on top of the curve, prepared to adjust as the situation evolves.

BS: What’s your assessment of the ECB facilities to provide cheap money to banks, how effective do you think they will be?

IA: All these measures will ensure that everybody who needs liquidity gets it, that there will not be immediate repercussions in terms of bankruptcies, either of corporates or of banks, so that there will not be an economic and financial second-round impact from the health emergency. I think that’s the spirit of these measures and I think they are going to be successful at that.

But that’s just the liquidity part of the story. The solvency part will be more in the fiscal area, and as we move to the second phase, inevitably we will see a real economic impact in terms of bankruptcies. Then there will be also long-term effects in the structure of the economy – the third phase. The second phase of the crisis will be not so much for the ECB, but for the fiscal authorities, and to some extent for the banking regulators, to address. The ECB will be involved as a supervisor, finding the right pace and the right way to lift the measures that were taken in order to facilitate the recovery. Right now we are still in the emergency phase, that requires crisis management.

‘There is a fundamental issue about bank profitability in Europe, and bank viability, which predates the crisis’

BS: European financials have fared poorly in terms of their share prices, and the ECB support has not helped much to support their valuations. What is your general assessment of European banks?

IA: There is a fundamental issue about bank profitability in Europe, and bank viability, which predates the crisis. But the question of how to ensure the medium-term well-functioning and the viability of the European banking system is a separate issue from today’ concerns. The ECB’s bank lending survey a few days ago showed that liquidity measures are helping, and that the conditional instruments of liquidity  (those where liquidity is granted on condition that banks lend to clients) are viewed positively. In the next quarter they will be even more effective in facilitating lending activity. But of course, lending means credit, and credit means debt. So there is a question of how this mounting debt, corporate, bank and public sector debt will be managed and reabsorbed in the second and third phase of this crisis. But that’s more for next year than for now.

BS: How do you view the regulatory easing that has been delivered so far, has it been appropriate and to what extent will it create new risks?

IA: Well, this is the time for supervisory and regulatory forbearance, which is something I had fought very actively against as a supervisor, but was one of the first to advocate when this crisis came (‘ECB should turn to supervisory forbearance’). There needs to be flexibility. This is going to be a very deep recession. You need to make sure that the banks are not constrained in their lending activity by the availability of capital or the need to set up provisions. The ECB bank lending survey showed that there has been some tightening of credit conditions by the banks, but it’s been relatively limited. Had the ECB supervision not reacted, the impact would have been much worse.

When the crisis ends and the recovery comes, the legislators and the supervisors will have to reconsider the banking union construction. Improvements will have to be made; banks will have to build up buffers and become more resilient. But this is for the future. But at this moment, the regulators and supervisors have to support the banks by showing flexibility.

BS: Are you worried about reports that US banks are withdrawing from Europe?

IA: I think that one of the long-term implications of this crisis will be a rethinking of globalization, not only in terms of health policy but trade, travel, border policies, and banking too. It is very possible that the next 10, 20 or 30 years will be very different from what we have seen in the last 20 or 25 years. We may see much more home-based banking sectors – which in Europe means, or should mean, area-wide. I do think that the European banking sector is able to take care of itself, but it’s very possible that there will be a retrenchment with less European banking activities in the US (to some extent we have already seen that), and less US activity in Europe.

‘I don’t see the economic conditions for inflation to pick up in a sustained way’

BS: Does this also mean that the ambition of the European banking union might suffer, that it will be more difficult to envisage a truly European system as opposed to more national activity?

IA: There are at present two problems in the banking union. One is that crisis management tools and authority are not up to the task. The Single Resolution Board does not have enough instruments, powers, and financial means, to take care effectively from Brussels of European banks in crisis. Legislators will have to look again at the functionality of the crisis management mechanism.

The second problem is that legislation and supervision do not allow sufficient scope for the banks to expand cross-border. The European legislation should be such that banks see obvious opportunities and advantages from establishing themselves cross-border. Currently the legislation does not allow that. Banks cannot move capital from a subsidiary cross-border to the mother company. Liquidity transfers are limited by national legislation. We see national ring fencing all over the place. Legislators and supervisors have to make a step further and ensure that area-wide banking becomes not only possible but also much more attractive than it is now.

Once that happens, we will see more European-wide banking, and we may also see the cross-border mergers and  acquisitions, often invoked but not seen so far. Banks currently don’t see advantages of them, only risks.

BS: In terms of sovereign solvency, how worried are you that there will be a debt crisis in Europe?

IA: Let’s take Italy as the most prominent example of solvency considerations. There’s no question that the debt situation will worsen very significantly: from around 135% of GDP at the end of last year, the debt will jump up to 160% and maybe more. But if we look at sustainability, and with the help of the ECB, at the moment the Italian Treasury is financing itself relatively cheaply, on average. The average cost of funding the Italian debt is well below 1%. That’s not the case at the margin, with the spread to Bunds around 240 basis points, but overall the situation should be manageable even if the debt goes up to 160 or 170% of GDP.

Italy has been able to produce a primary surplus of 1% of GDP or more for years, so with these numbers the sustainability condition more or less works out. The situation would get more difficult if inflation picked up. If inflation picked up significantly – say core inflation at 2-3% in a durable way – then he ECB might have to react, and if they react relatively strongly, real interest rates will go up and the sustainability of the certain public debts may be in danger. That’s a possibility in principle, but for the moment it’s not in the cards. I don’t see the economic conditions for inflation to pick up in a sustained way.

BS: In a recent opinion piece you strongly argued for the European recovery fund, which however still seems very controversial. What’s your assessment of where we stand on the political side of crisis management?

IA: We’re waiting for the European Commission’s proposal for the recovery fund, probably for the middle of May. What’s been done so far, I think, is appropriate. The program involving the European Investment Bank (EIB), the new European Stability Mechanism (ESM) health facility, and the SURE – the unemployment support facility – are adequate, at least for phase one of the crisis. For phase two though we will need more. When the bankruptcies kick in, and maybe financing problems too, including for some treasuries, then we will need something else.

I believe that in order to be effective, the recovery fund has to be large. The president of the commission has spoken about trillions, certainly more than one trillion. This is what people expect. The equity base of it has to go into the European budget. It may be relatively limited, 200 billion or so, so one has to leverage that in order to reach a critical mass. But the question is who leverages? Do you ask the firms, the corporates to pile up debt, or will it be the commission itself that borrows more in order to be able to lend more? If the fund counts on corporate borrowing then there may be a tight limit; corporates are already indebted and are hesitant to pile up even more debt. I think it’s important that the fund is structured in a way to help the solvency of public debt, in addition to avoiding excessive corporate debt. This calls for very concessional terms, including a sizeable grant component.

BS: Will this path be sufficient to keep the euro area together, will it be enough to pay for the pretty massive cost and debt increase? Or will there still be a need for countries to tap the ESM, including Italy?

IA: I think the Euro area is supported by two or three fundamental factors. First of all, the euro clearly enjoys the support of the public. The political support is definitely there, in every country, including those who have suffered the most in the crisis.

On the institutional side, the ECB has proved its worth. It’s working. And the euro has a solid second-level position as an international currency. All these things imply that there is a critical mass of support for the euro as a currency. Of course, that doesn’t mean we’ll be no more crises: we will certainly see more adjustments, more difficult situations as we are seeing now. But I strongly believe that, by now, the euro is fundamentally established within the international financial system.