Financial Regulatory Forum

Countries need timely exit from bank support – ECB’s Bini Smaghi

By Reuters Staff
January 29, 2010

MILAN, Jan 29 (Reuters) – The support measures put in place by governments and central banks to help the banking system are becoming less necessary and their withdrawal must be timely, a top European Central Bank policymaker said on Friday.

In a speech on bank lending, Executive Board member Lorenzo Bini Smaghi also said banks were interpreting a global regulatory overhaul in ways that restricted lending, and that he was worried about criticism in the United States of the Federal Reserve.

“It is crucial to prevent the banking system making prolonged use of support measures, developing a sort of ‘dependence’,” he said, and added a premature withdrawal of support could sharply reduce financial gearing putting economic recovery at risk.

The exact timing of exit depends on the strength of the economy, he said.

“With improving conditions in the economy and the financial markets, supportive measures by governments and central banks have progressively less ‘raison d’etre’.”

He said later he saw the euro-zone recovery as “slow, gradual and oscillating”.

Bini Smaghi also said low interest rates had contributed to the crisis by fuelling credit growth.

REGULATION

However, he said central banks would have difficulty using the interest rate instrument for two different objectives — controlling inflation and pricking asset bubbles — at the same time.

Therefore they should also have macro-prudential instruments to avoid excessively pro-cyclical lending, Bini Smaghi said.

He also rapped commercial banks for their interpretation of new regulations as hindering lending, whereas they are intended to ensure an orderly flow of credit. Banks say the need to rebuild capital bases under Basel 3 regulations is starting to affect bank lending decisions, he said.

“It shows that the banking system is interpreting the new rules in a restrictive way for lending,” he said.

“The alarm that seems to be widespread in the banking sector concerning the new rules seems to mask the intention of adapting to them via a reduced exposure to the real economy, rather than via a capital increase.”

Banks should use their recent profits to improve their capital base, not for pay, Bini Smaghi said, adding to the growing chorus of policymakers demanding bonus restraint.

Bini Smaghi said U.S. President Barack Obama’s proposals for the banking sector needed further measures.

“The initiative is heading in the right direction,” he said. “It is, however, not the final step.”

Obama last week proposed a law that would bar banks from betting in financial markets with their own money, known as proprietary trading. Called the “Volcker rule,” after Obama advisor Paul Volcker, the law aims to prevent banks from taking risks that drag them to the brink of failure.

Banks could also not own, invest in or sponsor hedge funds or private equity funds, and would set limits on the relative size of banks, the proposal said.

Bini Smaghi said the whole of the financial system, and not just traditional banking activity, needed to be subject to regulation, including hedge funds and investment banks.

The regulatory authorities also needed to be strengthened, especially as regards their independence.

“The debate under way in the U.S. where the most independent institution, the Federal Reserve, is subjected to attacks and pressures from different parts … aimed at reducing its powers, is worrying,” he said.

(For a copy of the speech, double click on: http://www.ecb.int/press/key/date/2010/html/sp100129.en.html)

(Reporting by Francesca Landini; Editing by Ruth Pitchford and Toby Chopra)

((stephen.jewkes@thomsonreuters.com; +39 02 6612 9695; Reuters Messaging: stephen.jewkes@reuters.com@reuters.net)

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