Bank of Lithuania
2015-07-03
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Good morning, dear Colleagues,

Welcome to Vilnius, everyone. And thank you for your interest in our event.

Please, believe me — and this is not just a polite phrase to begin a speech with — that we (my colleagues and I) truly highly value this opportunity to meet you all — speakers, panellists and participants with macroprudential policy expertise — everyone who kindly accepted our invitation to share their vision and experience. And of course, thank you to our keynote speaker Vítor Constâncio, Vice-President of the European Central Bank, for joining us.

According to the programme, we will have an intensive day today. I guess and I hope that we will hear different and, perhaps, even conflicting views.

Nevertheless, despite differences in views, the fact that we have all gathered here and now means “we are all in this together”.

And I believe that we share more than just an interest in the same subject of systemic risks. In my view, an additional “common factor” is our shared understanding of responsibility.

Let me justify my presumption: economists — both classics and modern stars — often argue that one of the most dangerous conditions for every economy at any time is a bad attack of economic pessimism. This opinion is voiced each time economic growth and credit expansion slow down.

I do not dare argue with classics such as Keynes, but is an attack of economic optimism a less dangerous state? History has shown that over-optimism distracts attention from spotting risks on time. Therefore, when growth curves skyrocket, the silent consensus is: this time is different.

Ladies and gentleman,

It is not worth counting how many such “different times” we have already had. However, it is really worth noting the similarities among all of these “different times”.

First, there were no institutions with an explicit mandate to monitor and prevent systemic risks in the financial sector.

Second, although no one was at fault, the final payer was always there — society and the tax payers, including those who had no relationship either with financial institutions, or credit. Recently we have lived through an unprecedented series of bank failures that have cost too much. Far too much. Some societies suffered losses related to bank crises that amounted to nearly half of their GDP.

Dear colleagues,

I do not intend to dedicate my speech to a review of the recent crisis. I would rather point to one more consistent pattern, common to all regions and all times.

From ancient times, people and states attempted to regulate credit markets, more so than the businesses of bakers or shoemakers. They tried, in modern words, to ensure responsible lending and borrowing. Remember the old rules and Shakespeare’s moneylender — the one who required a “pound of flesh” as collateral?  

You certainly know the regulatory actions of the US government after the Great Depression, as well as the past efforts of European countries.

But why then does history repeat itself?

One of the possible answers is that because we tend to forget lessons from the past.

If I had to illustrate the developments of the financial sector and its regulation in a chart, it would be a wavy curve. Crisis, followed by stabilisation followed by tightening of regulation. Then — recovery and increasing voices about “overly” strict regulation that hinder credit growth, plus, persuasion that the sector is capable of regulating itself… This would be followed by “loosening of the bolts”. Possibly even exaggerated deregulation on one side and maintaining — on the other side — the implicit or explicit government guarantees for the financial sector and consumers. This would naturally lead to irresponsibly aggressive expansion and recurrence of the “boom and bust”...  

This is how it repeatedly happened in the past. And that should mean that soon we will face headwinds against regulation. Does this mean that history will repeat itself?

There is no answer yet. We are creating the answer now ourselves. However, one thing is clear: our situation is unique in several aspects.

First of all — responsibility. Yes, I have already mentioned this word. And I will mention it again, since, in my understanding, it is the key word and the core element of macro-prudential policy.

We know well that although the term “macro-prudential” was mentioned in the late 1970s, in many countries it has been recognised that no single authority had the responsibility, powers and instruments to monitor the financial system as a whole and respond to systemic risks. There were analyses and theoretical discussions, but only a few examples of practical action.

Now, the responsibility is assigned. To us: central banks, supervisory agencies, financial stability committees. In many cases the institutions that are represented here today sought this responsibility and assumed this duty voluntarily. This reflects our attitude and gives hope to believe that this time could be different indeed.

Another thing that supports this expectation and distinguishes the current situation is our mandate. Together with the duty, we also obtained real powers to move from theory to practice.

Lithuania was one of the first countries that started using a set of private credit flow restrictions. In 2011, the Bank of Lithuania adopted responsible lending standards, which put limits on the loan-to-value and debt-service-to-income ratios as well as loan maturities.

If you are interested, my colleagues will gladly share their insights about the impact of these instruments. Most likely they will say: if these tools had been in place before the burst of the 2008 real estate bubble, the credit cycle would have been much smoother and the negative consequences would have not been so dramatic for our economy.

The last decade’s boom in housing prices in Lithuania went together with the sharp rise in the credit supply and was certainly accelerated by this short-sighted generosity. 

To illustrate: from 2004 until 2008, private credit was growing much faster than the Lithuanian economy and the credit-to-GDP ratio doubled from less than 40 per cent to almost 83 per cent!

During the same 4-year period the real housing prices increased by 240 per cent. It was the sharpest increase in the Nordic-Baltic region that ended with one of the deepest falls: the real prices dropped by 1/3 in a bit more than a year and a half, ravaging not only the sectors involved, but also the economy as a whole.

People say: every cloud has a silver lining. It was a drama and at the same time — a lesson. We took the lesson seriously. We took actions.

It surely was not, is not and will not be simple.

The former chairman of the United States Federal Reserve Bank, William McChesney Martin, once famously said that his job was to “take away the punch bowl just when the party gets going”. He talked then about “leaning against the wind” of inflation, but his famous quote has been recently used to illustrate the main objective of macro-prudential policy.

People do not like change in general. Especially if it restricts them. We experienced that in 2011, when we started to apply our responsible lending standards for the first time. We also faced it recently, just after we announced our intentions to modify these standards.

However, we are determined not to lose direction. Especially now, when the prevailing environment of particularly low interest rates requires special vigilance. We have to be prepared for interest rates returning to the “normal” level and help both lenders and borrowers always estimate their loan repayment capacity in a prudent way. As it has been said, our strategy should be “tilting against the wind” of building-up imbalances in the credit market.

Dear Colleagues,

In the beginning I raised the question: pessimism or optimism? I do not know the answer as to which attacks are worse. However, I know what is better — a prudent balance, caution and responsibility.

I wish us all of this in our daily work. And I wish you an interesting day and fruitful discussions.

And now I will gladly pass the microphone to our honourable keynote speaker.

Vítor Constâncio is the Vice-President of the European Central Bank, with more than a decade experience as Governor of the Banco de Portugal. He is a policy maker and academician, one of the key people in European banking who kindly agreed to share his views with the participants of the first conference on macro-prudential policy organised by Lietuvos bankas.

Please, Vítor, the floor is yours.