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Sink or Swim at the European Central Bank

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In her youth, Christine Lagarde was a member of France’s national team for synchronised swimming. The 64-year-old, who for the past six months has been running the European Central Bank (ECB), once won a bronze medal in her country’s national championships.

To excel at the sport requires an ability to appear graceful above water while pedalling frantically beneath the surface. Almost half a century on, Lagarde finds herself in her latest high-powered job swimming against all sorts of forces – the biggest one by far, coronavirus, completely unforeseen when she became the ECB’s first female president.

Lagarde is the fourth president of the ECB, the Frankfurt-headquartered central bank for the euro, since the institution was founded in 1998 (she follows Dutchman Wim Duisenberg, Frenchman Jean-Claude Trichet and, most recently, Italian Mario Draghi).

A former French finance minister, she arrived at the ECB from the International Monetary Fund (IMF), which she led for eight years. Some analysts highlighted her lack of central banking experience, but @Lagarde is an international political heavyweight, make no mistake.

During a speech in Frankfurt in her first month she weaved through challenges ranging from “trade tensions, new technologies disrupt[ing] conventional supply chains and workplace organisation, and potential new risks emerging from climate change”. She concluded that “we face a global environment that is marked by uncertainty”.

If Lagarde’s in-tray was stacked high then, coronavirus puts it at risk of wobbling over.

The crisis may prove so expensive that some European governments are ‘overwhelmed’ by the increase in public debt, according to one analysis published last month. The paper’s trio of authors, including two former ECB economists, said the consequences range from permanently lower growth in high-debt countries to a full-blown sovereign debt crisis that the ECB “might struggle to contain”.

Yanis Varoufakis, the former finance minister of Greece, has said the coronavirus recession is pushing the eurozone’s monetary architecture – tested almost ten years ago – beyond its limits. This was mentioned by DisruptionBanking a few weeks ago when we covered Yanis in our Article “Back to the Future“. Whether Lagarde can ‘save’ the euro is a question being asked.

The ECB’s most headline-grabbing reaction to date came on 18 March with its €750bn Pandemic Emergency Purchase Programme (PEPP)

Challenges keep popping up such as the recent Germany’s Constitutional Court ruling on ECB bond-buying but the ECB seems resolute.

Europe’s private banking fraternity watches on with interest (literally – more on that later).

Clearly the ECB’s primary remit is not to champion Europe’s commercial banks, but it sits as part of the European Union’s (EU) bank-impacting institutional architecture alongside the likes of the European Banking Authority (which relocated from London to Paris because of Brexit).

The bloc’s high-profile banking union and capital markets union (CMU) projects have progressed in recent years, although regulatory and (inevitably) market fragmentation remain. A private-sector coalition, Markets4Europe, launched last year to champion a ‘deeper, more integrated and competitive CMU’. An analysis published just a fortnight ago of banking regulation in the eurozone, focusing on Germany, and highlighting ‘vulnerabilities in the still-incomplete banking union, which is being tested in the context of the COVID-19 pandemic’ makes for interesting reading.

European bank structural reform (BSR) proposals have long since disappeared from the rear-view mirror. These included a UK-style proposal to split banks’ trading activities from traditional lending activities, and were derived from recommendations published in 2012 by a high-level expert group led by then-ECB governing council member Erkki Liikanen. Lagarde herself tapped into the then-prominent theme of structural reform during her IMF years, in 2013 describing the “the ‘oversize banking’ model of too-big-to-fail [as] more dangerous than ever” and calling for “comprehensive and clear regulation”.

But the European Commission said in 2017 that BSR’s purpose had ‘to a large extent’ been achieved by other measures. Finance Watch was distinctly unimpressed, saying it ‘deplored’ the Commission’s announcement.

Where do European banks now stand vis-à-vis their American counterparts? Much analysis in recent years hasn’t made easy reading for Team Europe. “It is not our remit to promote national, or even European, champions,” the ECB’s Andrea Enria is quoted as saying in a similarly angled media report. Here’s a further perspective.

Instead, the ECB’s focus is, of course, monetary policy, including keeping inflation ‘below, but close to, two per cent over the medium term’.

As highlighted in an ECB research paper published just last week, the institution has since mid-2014 pursued a policy of negative interest rates – the aim being ‘to stave off the unprecedented disinflationary forces that arose in the aftermath of the global and sovereign debt crises’.

This policy impacts banks, who, according to the FT last week, reckon they have paid €25bn through negative rates to the ECB since the rate headed sub-zero six years ago. The ECB’s paper concluded that negative interest rates have ‘had a broadly neutral impact on bank profitability so far’, a finding that the FT said ‘may be contested by some bank executives’.

Given the coronavirus crisis, everyone from US president Donald Trump to the Bank of England’s Andrew Bailey is weighing in on the merits of (and need for) – or not – negatives rates in their own jurisdictions.

Speaking to #DisruptionBanking, Grégory Claeys, a senior fellow at the think-tank Bruegel in Brussels, picks up on the importance to banks of the ECB’s negative interest-rate policy.

He says that while the €750bn PEPP programme made headlines as the ECB reacts to coronavirus, the institution has made two other decisions in recent months that, in his view, are likely to be more impactful on commercial banks.

The first was the ECB’s launch last autumn of a ‘two-tier’ system for remunerating excess liquidity holdings; the second was the additional targeted longer-term refinancing operations (TLTROs) announced on 12 March to provide banks with liquidity support. Although some coverage has been sceptical, Claeys says: “These new TLTROs are exceptional because the ECB basically decided to pay banks to take its loans in order to incentivise them to support the real economy.”

Keeping liquidity flowing is the name of the game.

Claeys reflects: “Christine Lagarde came into the role with a lack of direct experience on central bank issues and it’s been a rough start for her as she did not expect to face the largest recession ever recorded in the euro-area only a few months after her arrival. But the decisions taken so far to react to coronavirus shows that she is up to the challenge.”

There’s still time for other priorities – just last week Lagarde re-tweeted an ECB post about gender targets.

While she has expressed her enthusiasm for combating climate-change and developing fields such as central bank digital currencies.

But given the severity and urgency of coronavirus, the ECB leader will need all her piscine poise to find favour with every judge.

Author: Ian Hall