The head of Europe's Central Bank spoke on Wednesday about crisis management in light of the ongoing financial markets and economic turmoil, remarking on areas for improvement to avoid such major turbulent episodes.
Addressing the European Parliament in Brussels, ECB President Jean-Claude Trichet said the EU needs to improve in assessing certain types of risk and ensuring that institutions have the right incentives to do so, according to a prepared statement released today. He also mentioned the need for better communication amongst regulators and the responsibility of the Central Bank to anchor inflation expectations.
He cautioned that while it was still early to draw conclusions it seems to me that we know already a number of areas where it is certain that we will have to engineer significant improvements.
Trichet's presentation comes as financial markets worldwide have been falling steeply amid uncertainty over the possibility of a recession in the United States. The negative effects of the current crisis began to show up last year as financial services companies in the U.S. started to suffer due to defaults in higher risk home loans to clients with poor credit. Since then, the U.S. economy has shown signs of slowing growth, with a decrease in consumer spending.
Many financial services companies, including major banks, mortgage lenders and insurance companies have taken steep losses related to those loans. With the crisis ongoing, expectations that banks could disclose additional losses in the coming quarters have increased the anxiety about how bad the results are and how to properly price risks.
Financial products created from loan bundles have come under scrutiny as investors have piled up losses. Banks will draw important lessons about managing risk, Trichet said. Regulations may need to change to take these products and the vehicles to deliver them into account, he added.
The experience of the turmoil has highlighted that some categories of risks have been underestimated by banks including liquidity risk relating to liquidity commitments to conduits and SIVs, concentration risk in structured products and reputational risk associated with sponsoring special purpose vehicles, he said.
Everyone along the financial food chain involving those products, from loan originators to final investors, should have the right incentives to properly assess and monitor risks, he said.
The role of public authorities in the matter is to promote the best possible risk management for institutions, and better communication between various authorities, he noted.
I will say that the present experience fully confirms the position taken a long time ago by the Eurosystem according to which a close institutional link between central banks and banking surveillance authorities is extremely important, he said.
Trichet also approached the issue of policy regarding interest rates and their relation to markets.
I trust that in all circumstances, but even more particularly in demanding times of significant market correction and turbulences, it is the responsibility of the Central Bank to solidly anchor inflation expectations to avoid additional volatility in already highly volatile markets, Trichet said.
Trichet also touched upon the ECB's interest rate policy throughout the crisis. The central bank has maintained the interest rates banks charge each other overnight on hold at 4 percent since its last hike in June.
In contrast, its U.S. counterpart, the Federal Reserve has decreased lending rates from 5.25 percent last summer to their current 3.5 percent levels in an effort boost the economy by encouraging borrowing and spending. However the U.S. policy has come at a price, with the dollar falling to record lows versus the euro.
Trichet said it is important for the ECB to ensure an orderly functioning of the money markets at the level of interest rated required for anchoring the inflation expectations.