In 2014 the Single Supervisory Mechanism (SSM) Regulation came into force, under which the ECB became responsible for the direct supervision of significant credit institutions in the euro area. This new policy framework supports both the implementation of monetary policy and helps build resilience in the financial system. Financial and business cycles can potentially be de-synchronised, meaning financial imbalances can grow in an environment characterised by relatively muted inflation. And in such an environment, the use of monetary policy to counteract financial imbalances may not be optimal, since it may result in substantial deviations of aggregate output and inflation from their desirable levels. In this situation, macroprudential policy, addressing financial imbalances, can complement the long-run objective of monetary policy.
The unconventional monetary policy measures and the improvements to the regulatory architecture have put the euro area banking system in a stronger position to transmit the ECB’s credit impulse to firms and households across the monetary union and to ensure sufficient financing to sustain the recovery – which is exactly what we have seen. In the first quarter of 2017, annual loan growth to euro area households stood at 2.6% and non-financial corporations at 1.6%, up from respective troughs of -0.6% in the second quarter of 2014 and -3.6% in the third quarter of 2013. Bank lending rates for both firms and households have dropped by around 110 basis points over the past three years and are now at historical lows.
With the resilient recovery underway, the tone of the debate in Europe surrounding financial stability has shifted. Some have expressed concerns that monetary policy measures are having unwanted side effects on financial stability. This is not a new subject for academics or central bankers: monetary policy always has side effects. But the use of unconventional measures by central banks has generated greater awareness of the issue.
Yet the current environment also suggests that close monitoring is necessary in the following three areas: the effect on risk-taking in bank lending, the impact on bank profitability and the impact on institutional investors. The chalanges mentioned by Mario Draghi, during the the First Conference on Financial Stability organised by the Banco de España (Madrid, 24 May 2017) are the potential conflict of interest, procyclical nature of some of the instruments in post-crisis macroprudential policy toolkit as well as its regulatory arbitrages or possible cross-border leakages in EU regulation.