MONETARY POLICY

Patience Is a Virtue

Francois Villeroy de Galhau, governor of the Bank of France, pauses during an interview during a Banque de France symposium in Paris, France, on Tuesday, Jan. 12, 2016. The European Central Bank has the tools available to act further if needed, as inflation is still below target, Governing Council member Villeroy said. Photographer: Marlene Awaad/Bloomberg *** Local Caption *** Francois Villeroy de Galhau
The governor of France's central bank is optimistic that the Italian banking crisis won't spread to his country.
  • Why it matters

    Why it matters

    Europe’s response to the global financial crisis was to prevent worse things for the economy, like the Great Depression in the 1930s, said Mr. Villeroy de Galhau.

  • Facts

    Facts

    • The rate of return on German savings accounts has been positive since 2015, said Mr. Villeroy de Galhau. Before that, it was negative.
    • The European Central Bank’s inflation target was set by mutual agreement in 2003 at just under 2 percent.
    • Today that rate is the consensus of all major central banks, including the ­U.S. Federal Reserve, the Bank of England and Bank of Japan.
  • Audio

    Audio

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Late on Friday night, the European Central Bank will publish the latest round of stress test results gauging the health of Europe’s banks. Much of the focus has been on Italy, but what about neighboring France?

Shortly before the results were published, the governor of France’s central bank said he isn’t worried that the Italian banking crisis could spill over into his country.

“The French banking system is extremely sound,” said François Villeroy de Galhau, in an exclusive interview with business weekly WirtschaftsWoche, a sister publication of Handelsblatt.

Mr. Villeroy de Galhau was appointed head of the Banque de France in September 2015. He is descended from the family that co-owns the Villeroy & Boch ceramics company, located for two centuries across the French border in the Saarland region of Germany.

“The discussion on monetary policy is legitimate. What is not legitimate is calling into question the independence of the ECB.”

François Villeroy de Galhau, Governor, Banque de France

He started in government as a European policy adviser to the French finance minister in the early 1990s. More recently he served as chief operating officer at BNP Paribas before being appointed to head the French central bank in September 2015.

As governor, Mr. Villeroy de Galhau also represents France on the governing council of the European Central Bank. He is considered a supporter of ECB President Mario Draghi’s easy-money policies.

In the interview, Mr. Villeroy de Galhau urged patience with the ECB’s monetary policy and inflation in the 19-nation euro zone. He also rejected the notion that monetary policy is only harming – and not helping – banks in Europe, and strongly rejects any attacks on the independence of the Frankfurt-based central bank.

As for the banking crisis, he didn’t rule out an E.U. bailout for crisis-ridden Italian banks, but said it must be done in accordance with European regulations.

 

Mr. de Galhau, Europe fears another banking crisis, this time coming from Italy. French banks, with €280 billion ($312 billion), are far and away more in the fire with Italian banks than German banks. How great is the danger of contagion?

The French banking system is extremely sound. I am not worried.

Really? There is no danger at all threatening French banks?

Rather than fearing a risk of contagion, it would be better if we took a look at the situation of European banks today as a whole. Since the 2008 financial crisis and the founding of the banking union in 2013, we have made great progress in strengthening the banking system. By 2015, French banks had more than doubled their solvency ratio — which is the equity capital base in relation to risks taken — from less than 6 percent in 2007 to more than 12 percent in 2015. We find this progress in almost all E.U. countries. Much work has been done. In Italy, as well, not all financial institutions are suffering under bad debts, just a few. I hope that the problems can be resolved quickly.

Italy’s prime minister, Matteo Renzi, is demanding a state-funded bailout for banks in crisis – in contradiction to the banking union’s new “bail-in” regulation. The ECB president, Mr. Draghi, seems inclined to accommodate his countrymen.

One should be careful in dealing with such rumors.

Following the latest meeting of the ECB, Mr. Draghi said a state-funded backstop would be “very useful.” Wasn’t that clear?

There might possibly be state-funded aid – but it would be in accordance with European regulations. The Italian authorities are working in that direction, in order to find a solution that is compatible with European rules and based as much as possible on market mechanisms.

At the same time, banks everywhere in Europe complain about the ECB’s low-interest rate policy. Does the accommodative policy endanger the business model of credit institutions?

This is another subject. When commercial banks talk about the ECB’s policy, they like to single out negative interest rates. But the monetary policy we pursue – for very good reasons – has other elements, and they benefit the banks. Banks are provided with loans at extremely favorable conditions through the TLTRO II program. We place interest-free loans for a period of four years at their disposal. When the banks expand their loans accordingly for the economy, they are even given a premium. The volume of borrowing has again increased, thanks to the ECB’s monetary policy. The risk that banks must bear, on the other hand, has fallen sharply. That’s good for their profitability.

Draghi-Constancio-Bloomberg
ECB President Mario Draghi’s easy-money policies have gone down better in Mr. de Galhau’s France than in Germany. Source: Bloomberg

 

So banks shouldn’t be complaining?

The overall picture of European banks, resulting from the monetary policy, was positive in 2015. Naturally, profits suffer when negative interest rates continue, and we must keep it in mind. But we should consider the whole picture and not just one little corner.

So why then does the new bank stress test mostly focus on the consequences of rising interest rates? And not those of the zero rate policy?

On the contrary! The baseline scenario considers persistently low interest rates. The stress scenario, on the other hand, examines a sharp increase in interest rates which would have more adverse effects. Stress tests are, in general, administered meticulously, just as in the United States and Great Britain. Their findings are absolutely reliable.

Many Germans are afraid that the ECB’s policy will eat up their savings. What is your response?

The actual rate of return on German savings accounts has been positive again since 2015. Before that, it was negative. That must be stressed; and the ECB’s policy needs to be better explained. Our response to the global financial crisis was the same as in the United States. Carrying out these policies was the right thing to do: we had to prevent worse things for the economy, like deflation during the Great Depression in the 1930s. At the same time, we weren’t acting in the interest of a couple of countries or banks, but rather in the interest of all citizens of Europe. Moreover, it was important to significantly strengthen banking regulations and to set up rescue mechanisms for banks, involving bank shareholders and creditors in the potential bail-outs. We did that.

Not everybody is convinced of that.

The ECB’s monetary policy is not an invention of recent years. It corresponds to the mandate entrusted to the ECB when it was set up: a politically independent institution that strongly resembles the mandate of the Bundesbank.

“Our quantitative easing program is efficient. But one must be patient. My favorite word in German is “Nachhaltigkeit,” perseverance.”

François Villeroy de Galhau

This mandate is price stability: to prevent too much inflation, but also to fight against the risks of too little inflation – such as we see today. The inflation target was set unanimously by the Governing Council in 2003 as a medium-term inflation rate close to but below 2%. That was long before the crisis and long before Mario Draghi. At the time, Otmar Issing was the ECB’s German chief economist. Today it is the consensus of all major central banks, the ­U.S. Federal Reserve, the Bank of England and the Bank of Japan. We are all conducting “non-standard” policies, which are nevertheless orthodox because they are in keeping with our mandate.

Where is the limit for negative interest rates?

One of the limits is where they would be passed on to private households or to small and mid-sized companies (SMEs). So far, however, not a single European bank is passing negative interest rates on to private citizens or to SMEs.

Not yet.

That will not be the case in the foreseeable future, in my opinion. Just look at Switzerland and the Scandinavian countries. Interest rates are even more negative there, but it doesn’t affect consumers. As I said, negative interest rates are just one tool among others, a key on a much wider keyboard. We play all the keys.

So far, the ECB has fallen short of its target for inflation in the euro zone. Why? 

Inflation depends on many factors, not least the price of oil. That is why we always say that it is a medium-term objective. But to give you an indication, our latest forecast assumes 0.2 percent for the euro zone in 2016, 1.3 percent in 2017 and 1.6 percent in 2018. In other words, we are moving in the direction of the 2-percent objective.

Nevertheless, so far your policy of quantitative easing can hardly be described as a success. 

Our quantitative easing program is efficient. But one must be patient. My favorite word in German is “Nachhaltigkeit”, perseverance. Our monetary policy is characterised by perseverance. Without quantitative easing, inflation would be even lower. The estimates by national central banks, including the Bundesbank, agree: our policy contributes at least a quarter of a percentage point to inflation each year. Depending on the model, it stimulates growth by 0.4 to 1.0 percent. However, Wolfgang Schäuble [Germany’s finance minister], Mr. Draghi and all of us agree: monetary policy cannot be the only game in town.

078 ECB - WTB Mario Draghi euro zone 2015 Neu 2016-04-14-01

 

Will you continue with quantitative easing? 

The priority is to consistently implement the measures decided in March. Last week, at our Governing Council meeting, we restated our commitment to the €80 billion monthly asset purchases and the TLTRO-II program.

If inflation actually does reach 1.6 percent in 2018, will the ECB monetary policy cease to be accommodative? Or will the ECB not be prevented from raising interest rates by strong political pressures?

It’s July 2016 and you’re asking me about the ECB’s monetary policy in 2018?! I can guarantee you that we will remain true to our mandate. We are today, and we have said that we will keep low interest rates at least until March 2017 – and beyond, if necessary. Look at what has happened in the United States, where the Federal Reserve took unconventional measures long before we did. Step by step they are taking them back. They stopped their net purchases of assets in 2014 and started to raise interest rates at the end of 2015. The Fed is showing a progressive way out. But we haven’t reached that point yet.

How do you explain that the French are not as upset about ECB policies as many Germans are? 

Perhaps because of a different awareness of history. The times of hyperinflation are still present in the consciousness of Germans. In other countries, however, like the United States and a few E.U. countries, people remember deflation and its severe consequences for economy and society, in the form of mass unemployment.

“Negative interest rates are just one tool among others, a key on a much wider keyboard. We play all the keys.”

François Villeroy de Galhau

The discussion on monetary policy is legitimate. What is not legitimate is calling into question the independence of the ECB. Today deflation threatens the economy and citizens alike – in Germany as well as in the rest of Europe. By the way, Germany isn’t just a country of savers, but also of entrepreneurs, real-estate buyers and consumers. We have to protect everyone, not just one category. As Jens Weidmann, the president of the Bundesbank, said: “Men are not just savers.”

In addition to government bonds, the ECB is now buying corporate bonds which comprise nearly 50% of B-rated bonds. Couldn’t this become a major risk for taxpayers?

This percentage is the number of eligible securities but does not indicate the volumes of associated purchases, which I will not comment on. The rule we have imposed on ourselves is that we only buy investment-grade securities, that is, those with sufficient collateral. The diversification of securities is the best protection. 

But the purchases also include bonds from Telecom Italia, K+S and RWE. They don’t necessarily have the best ratings.

None of them violates the rules I mentioned. Here, once again, we keep our goal in mind — namely that we want to protect the real economy, companies and their investments from the volatility of financial markets.

Don’t you see a risk that companies will use cheap money from the ECB for share buybacks or bonuses?

This debate is being waged in the United States. I think the risk is lower for Europe. It is each company’s responsibility to have a long-term strategy. The ECB and the national central banks cannot be responsible for investigating each company’s strategy and making it a condition of its purchases. That would be an overly interventionist policy.

France will elect a new parliament and new president in 2017. Elections are also coming up in Germany. What would you like to see for Europe?

To stick with the economic order that I advocate: The monetary policy is already doing a great deal. For growth and employment in Europe, I believe that we need a Financing and Investment Union starting this year and a collective strategy, supported by a euro zone minister of finance after 2017.

 

This article first appeared in the business magazine WirtschaftsWoche. To contact the author: wirtschaft@wiwo.de

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