by Xavier MUSCA,

Deputy CEO, Crédit Agricole S.A.


A Dire Situation

Mr. Musca noted that today’s concern seem to dash the hopes generated by the measures taken in the aftermath of the financial crisis, when courageous monetary policy drove interest rates and volatility down. Growth has remained sluggish, which explains the debate around secular stagnation. One key element is missing today, according to Mr. Musca: investment.

While it is difficult to explain the rationale behind this, the undeniable result is that unemployment is high, and public debt still elevated, even if efforts have been conducted in some countries. In some cases, there has in fact been an explosion of total debt, most notably in China. The transmission mechanism for monetary policy seems to have lost its ambitions and on top of that, in Europe, oil prices have dropped, limiting the impact of ECB skewing. The drop in oil price is mainly driven by supply factors, and it is highly uncertain that oil producers will succeed in coordinating. As a result, short-term inflation expectations should remain at a low level, making the ECB’s task more difficult. Interest rates are going to stay low, due to a combination of saving glut, QE glut and Secular stagnation.

Mr. Musca remarked that monetary policies seem to have reached their limits: “The ECB is buying more by far than the amount of the total net issuance in the Eurozone. The Bank of Japan has become the primary holder of Japanese government bonds. Its balance sheet is now equal to 80 percent of Japan’s GDP, which is obviously a record high. We can and should be pleased that the central banks, through their action, succeeded in calming tension and reducing credit spreads. The ECB deserves particular credit for its crucial role at the difficult moment of the Eurozone experience between 2010 and 2012. But we must admit that some of today’s financial stability is partly artificial. It can only be effective if growth actually recovers,” he said.

 

Financial Stability Through Real Recovery

Many of the Forum’s speakers spoke on how, precisely, to achieve this, but Mr. Musca said the answer is not a straight-forward one: “First of all, I believe that continuing with an aggressive negative interest rate policy is both less necessary and more dangerous than we realize. My second conviction is that European growth strategy will not make sense without a clear policy regarding the banking sector. As for the legitimate objective of keeping interest rates very low for a long period, the most appropriate instrument is obviously quantitative easing. Finally, negative interest rates are dragging down banks’ profitability. This is occurring at a time when the banks are struggling to earn the market favours, while being asked to lend more.

 

Low Rates VS. Bank Cost of Capital

Mr. Musca said much has already been done, with regulators and supervisors making efforts to clean up and strengthen the banking sector. Through higher cap to liquidity ratios, liquidity buffers, resolution mechanisms and resolution funds, significant sums of money have been put aside by the sector for its own insurance. These measures were essential, Mr. Musca affirmed, and the banking sector is now stronger for it. However, he did caution that regulators and monetary authorities are not paying sufficient attention to one issue that is becoming critical in the transmission of monetary policy: the banks’ cost of capital. “Interest rates are down, but the cost of capital remains around 10 percent, which is considerable in real terms,” Mr. Musca said. He explained that this trend is due to the weight of the past crisis and the fact a return to normal has not taken place. Regulatory uncertainty is also a factor — regulation, which aims to prevent crisis, does not spur growth. Finally, normally low interest rates and rate curves have a direct impact on profitability.

So, what can be done?

 

The Way Forward

I am convinced that the economic recovery in Europe can only be real and strong if the banking sector itself is very strong.

Mr. Musca said we must think about aligning prudential regulation better with monetary policy. Regulation on risky assets should also be amended. “Everyone — the IMF, the ECB, the Bank of England, the European Banking Association – is asking for change,” he asserted, adding, “Market union will be the catalyst for these changes, which include market integration, support for SMEs and securitization.

Mr. Musca third recommendation is to facilitate the formation of large pan-European banks that can ensure better risk diversification. “By concentrating efforts on systemic risks and contingents, regulators and supervisors are actually encouraging the emergence of purely national players. It would be much wiser, in my view, to facilitate the formation of large, truly pan-European banks that could withstand specific localized shocks,” he said. Finally, Mr. Musca recommended the implementation of competition rules in a more flexible way, so as to facilitate banking system restructuring where necessary.

According to Mr. Musca, we are tasked with restarting our economy. “Over the course of the past two days of rich discussion and debate, we have all been encouraged to think outside the box. I hope that through this platform, you have been motivated and incentivized to do just that,” he concluded.