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Tough decisions lay ahead

Tough decisions lay ahead

​​​​​​WSBI-ESBG's Chris De Noose explores public policy around banking during Covid-19 pandemic

BRUSSELS, 17 April 2020

>> See related piece by Chris De Noose

>> Learn more: Covid 19 and WSBI-ESBG

The following opinion piece was authored by WSBI-ESBG Managing DIrector Chris De Noose.

Prepare for the unknown. That's especially timely advice as we witness Covid-19 ravage economies and quietly grip society.

While people stay close to home as countries fend off coronavirus, a question surfaces as to why we have so much unrest. A commentary piece published recently by former French​​ central bank and EBRD president Jacques de Larosière tries to answer that question from a global, EU and refreshingly local lens. Featured in the SUERF Policy Notes newsletter, he argues that tough decisions needed before the crisis made things worse. Governments and regional groups like the European Union need to do better. Doing so will help people, local communities and the banks that serve them.

Mr. de Larosière's prescient view on the conundrum now faced by central bankers – monetary financing of government crisis spending – makes for good reading, especially the overall banking sector's response in a low-interest-rate world. The reader becomes well aware that central banks, including the European Central Bank, do much of the heavy lifting to keep the economy afloat – as they should. In Europe, de Larosière notes that the European Central Bank can now buy up some €1 trillion euros in debt as emergency spending measures as more debt issuance flows into the market by national governments. In the U.S., monetary financing of the Treasury looks unlimited and the Fed now accepts private securities collateral. As monetary policy and fiscal policy become intertwined it requires careful and sober management, as the FT's Martin Wolf warned recently.

In populist-tinged political fights, farming out economic policy to the ECB gives politicians space and a scapegoat when addressing already fragile government budgets and managing debt. Before Covid-19, those debt levels on average stood at around 80 percent of GDP, according to Eurostat – with seven EU member states about that level.

As additional money flows from on high, government coffers and central bank balance sheets balloon. Because of this, interest rates will remain rock bottom too. Banks that depend on deposits for funding, such as German savings banks, abhor low rates. Near-zero, below zero and at zero rates penalise savers and move investment to riskier assets. Saddled with hard-to-shake low-interest rate policy, central banks in the Covid-19 times find new, perhaps controversial ways to provide liquidity to grease the economic machine. Let's just hope it doesn't spell suicide for market-based economics in today's populist-driven politics.

We hear a lot in the news about asset purchases by central banks that go beyond government-issued debt. To be sure, hoovering up corporate bonds and municipal debt provides a needed lifeline for firms seeking to build up needed cash and keep local authorities afloat. But moral hazard surfaces when governments step in, as Mr. de Larosière warns, oftentimes taking big stakes in firms. How active will governments be when they assume boardroom seats?

Banking, much like politics, is local, even in a globalised and interconnected world. The entire financial sector has a clear role to play to keep the economy humming along, especially in cities, rural areas and everywhere in between. As distressing country-by-country coronavirus statistics pile up, some 885 locally focused savings and retail banks in Europe keep an eye on the 'real economy'. They take a regional and responsible approach – maybe without the handshake but a smile (at a safe distance). Retail focused, they work with business owners and households to find the best way to get through. It's a prudent approach too.​

Central bankers like Mr. de Larosière know well that if SMEs and supply chains evaporate, it jeopardises a trillion euros in financing now on savings and retail banks' balance sheet. This mustn't happen, and it won't. The recent €540 billion package by the Eurogroup, along with measures by EU institutions, and national governments can and will help financial institutions like savings and retail banks to ensure companies of all shapes, sizes and situations get the needed oxygen to breathe a little easier, keep moving, maintain their payrolls and prepare for a healthier future.

Good politicians are adept at making future predictions, as Winton Churchill noted, and explaining their failure afterwards. Mr. de Larosière's five-bullet guide for immediate responses by Europe may in fact work. His call to finalise the long-awaited EU budget – with enough resources to deal with the epidemic – looks unassailable. A more contentious point is his proposed use of coronabonds – token amount or not – earmarked for “additional virus-caused health expenditure". In all reality it looks dead. Hardest to achieve among this solutions: apolitical agreement on the principles governing “re-entry" after the crisis, notably structural reforms and conditional restructuring of public debts , especially as populism gains ground at election time.

Post-Covid-19, whenever that arrives, will be rife with tough decisions. In so few words, Mr. de Larosière provides a broad set of ideas to help policymakers in Europe navigate the unknown. They should have a read.

Chris De Noose.

European Institutions; European Supervisory Authorities (EBA-ESMA)