"Central banks and financial stability"
Second ECB Central Banking Conference, 24 and 25 October 2002, Frankfurt am Main
The transformation of the European financial system
Press summary - Policy panel
Tommaso Padoa-Schioppa, Member of the Executive Board, European Central Bank
Tommaso Padoa-Schioppa's paper outlines the role of central banks in financial stability and central banks' policy tools in this area. Based on theoretical and historical analysis, the paper contains a number of key points. First, central banks are bound to be involved in financial stability for two fundamental reasons: (i) as the bankers' banks, central banks must ensure the soundness of their counterparties, and (ii) they have the exclusive capability to create final liquidity. Thus, central banks play an important role in maintaining financial stability, independent of the prevailing supervisory institutional structure.
Second, the profound transformation of the financial system over the past decade has potentially changed the types of financial crisis we might face. In particular, recent crises have shown the growing importance of liquidity and contagion risks, which fall within central banks' inherent interest and expertise. As a consequence, the role of central banks in preserving financial stability can be expected to further increase.
Third, Padoa-Schioppa explores the borders and interplay between financial stability, monetary policy and prudential supervision. While in special circumstances monetary policy could be confronted with a trade-off between price and financial stability in the short run, strong synergies between price and financial stability should prevail in the long run. Since a successful monetary policy (successful in keeping prices stable) may not always be sufficient to prevent financial instability, central banks cannot be indifferent to financial stability as such. Further, strong synergies also exist between financial stability and prudential supervision: the successful conduct of both functions requires close co-operation and an open exchange of information.
Fourth, the paper reviews the tools available to central banks for maintaining financial stability. It argues that central banks' tools go far beyond the provision of liquidity in times of crisis. In particular, central banks' activities with respect to financial stability have become increasingly preventive. Setting standards, performing oversight (e.g. in payment systems), and providing the market with analyses and assessment have become increasingly important. As a result, the potential for moral hazard that arises from central banks being the lender-of-last-resort to illiquid institutions is mitigated.
Finally, Padoa-Schioppa describes the current euro area institutional setting with regard to financial stability. While the Eurosystem only has limited involvement in supervisory tasks, it has the typical instruments for financial stability that non-supervisory central banks have in their toolbox. As the financial system in the euro area is integrating rapidly, financial stability has become a euro area-wide issue. This strengthens the case for a further deepening of the euro area-wide perspective on financial stability.
Kaiserstrasse 29, D-60311 Frankfurt am Main
Tel.: +49 69 13 44 74 55, Fax: +49 69 13 44 74 04
Internet: http://www.ecb.europa.eu
Reproduction is permitted provided that the source is acknowledged