Science & Technology
Christine Lagarde: Hearing of the Committee on Economic and Monetary Affairs of the European Parliament
It is a pleasure to be with you again today for our second regular hearing this year and immediately after celebrating the ECB's 25th anniversary. I am delighted that several members of this Parliament were able to join the celebrations in Frankfurt a few days ago, reflecting the close and fruitful dialogue our institutions have always maintained. Since the ECB's creation in 1998, members of its Executive Board have attended over 100 hearings before this Parliament. This engagement has been central to the ECB's accountability and has contributed to the euro becoming a currency that our fellow citizens trust. Let us now turn our attention to the current matters at hand. Let me start by providing a brief overview of the economic outlook before going on to discuss our latest monetary policy decisions. Economic outlook Growth in the euro area nearly stalled in early 2023. Activity is being supported by lower energy prices, easing supply bottlenecks and fiscal policy support to firms and households. As the energy crisis fades, governments should roll back the related support measures promptly and in a concerted manner to avoid driving up medium-term inflationary pressures, which would call for a stronger monetary policy response. The ECB welcomes the European Commission's recommendation to Member States to wind down in 2023 the fiscal measures taken in response to the energy price shock. Domestic demand, especially consumption, remains weak. Business and consumer confidence indicators point to weak activity in the second quarter and remain lower than before Russia's unjustified war against Ukraine and its people. We see a divergence across sectors of the economy. The manufacturing sector is still working through a backlog of orders, but its prospects are worsening. Meanwhile, the services sector remains resilient, owing in particular to the reopening of the economy after the pandemic. Household incomes are benefiting from fiscal support measures and the strength of the labour market, with the unemployment rate having fallen to a new historical low. Looking at inflation, according to Eurostat's flash estimate, headline inflation has declined from its October peak and stood at 6.1% in May. While base effects have led to some variation in energy inflation in recent months, the rate declined to -1.7% in May. Food price inflation remains elevated but is decreasing and stood at 12.5% in May, down from 13.5% in April. Price pressures remain strong. Inflation excluding energy and food declined to 5.3% in May from 5.6% in April. Upside pressures on both headline and core inflation are still coming from the pass-through of past energy cost increases and supply bottlenecks, which are nonetheless expected to fade gradually. The latest available data suggest that indicators of underlying inflationary pressures remain high and, although some are showing signs of moderation, there is no clear evidence that underlying inflation has peaked. Wage pressures have strengthened further as employees recoup some of the purchasing power they have lost as a result of high inflation. Moreover, in some sectors firms have been able to increase their profit margins on the back of mismatches between supply and demand and the uncertainty created by high and volatile inflation. ECB's monetary policy High inflation is putting a strain on people living in the euro area. As energy inflation – which imposed a notable burden on low-income households – declines, the inflation differential between low and high-income consumers starts to fade away. Nevertheless, high food inflation continues to weigh on low-income households in particular. We are fully committed to fighting inflation and we are determined to achieve its timely return to our 2% medium-term target. This commitment to price stability contributes to economic growth and employment in the medium term and hence to reducing inequality. In the light of the ongoing high inflationary pressures, in our May meeting we decided to raise the three key ECB interest rates by 25 basis points. We also announced that we expect to discontinue the reinvestments under the asset purchase programme (APP) as of July 2023. Our rate hikes are being transmitted forcefully to financing conditions for firms and households, as can be seen in rising lending rates and falling lending volumes. At the same time, the full effects of our monetary policy measures are starting to materialise. Recent ECB staff analysis indicates that the effects of monetary policy tightening on real activity and inflation can be expected to strengthen in the coming years, but our assessment is surrounded by significant uncertainty.1 Our future decisions will ensure that the policy rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to our 2% medium-term target and will be kept at those levels for as long as necessary. We will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction. In particular, our policy rate decisions will continue to be based on our assessment of the inflation outlook in the light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission. As requested by you, let me now discuss the financial stability outlook. Financial stability is a pre-condition for price stability and vice versa. Financial stability in the euro area has proved robust so far, but we continue to assess possible risks, taking into account a wide range of indicators.2 Euro area banks' exposure to the recent banking sector stress which arose in other regions has been limited. But challenges to funding and asset quality may weigh on future profitability. More broadly, as financing conditions tighten, we will gain more insight into the resilience of euro area firms, households and banks. The medium-term orientation of our monetary policy strategy allows us to consider financial stability in monetary policy decisions if this supports the pursuit of price stability. Conversely, price stability remains as crucial as ever for durably preserving financial stability. We do not see a trade-off between financial stability and price stability in the euro area. Over time, the pursuit of price stability through monetary policy, and of financial stability primarily through macroprudential policy, are complementary. In addition, the ECB has the tools to provide liquidity to the euro area financial system if needed to preserve financial stability and the smooth transmission of monetary policy. We remain committed to price stability. And to support financial stability, it is essential that you, as co-legislators, make tangible progress towards completing the banking union and that you strengthen regulatory policies to further enhance the resilience of the euro area financial sector. Conclusion Allow me to conclude. In 1998, former ECB President Willem Duisenberg stressed that the European System of Central Banks (ESCB) should be open, transparent and accountable, noting that "the most important challenge for the ESCB is to win the confidence of the citizens of Europe".3 25 years on, this is still an important challenge, and we are working hard to further foster trust in our institution. But the ECB cannot do this alone. Today's dialogue with you, who represent the people of Europe, is essential to that endeavour. This is why I am delighted that I have just signed, together with the President of the European Parliament, an Exchange of Letters between our two institutions. Building on our close and fruitful dialogue over the past 25 years, this Exchange of Letters will allow us to better structure our interactions and facilitate effective cooperation.4 Together we must do all we can to keep listening and responding to concerns of European citizens. Thank you. I now stand ready to take your questions.
Yesterday we published the latest edition of the ECB's Financial Stability Review, which is issued twice a year. In my remarks today, I will provide you with the main findings of our analysis. Two key developments have shaped the macro-financial environment over the past six months. First, there has been some improvement in the growth and inflation outlook since late last year. Macro-financial conditions have improved on the back of a robust post-pandemic recovery, fading global supply chain disruptions and lower energy prices. At the same time, the outlook remains fragile, given downside risks to growth and relatively sticky core inflation. A second key recent development concerns financial turbulence witnessed this spring, with the spotlight increasingly turning on systemic risk concerns following bank failures outside the euro area. Strains in the US and Swiss banking sectors in March introduced an element of stress into a highly uncertain environment. While the fallout experienced by euro area banks was limited, these events have served as a timely reminder of just how much the preservation of financial stability depends on the shock-absorption capacity of the financial system. All the more so in an environment where financing conditions are being tightened to tackle elevated inflation around the world. Framed by these recent developments, our current assessment is that financial stability vulnerabilities in the euro area remain elevated. Tighter financing conditions to address high inflation have contributed to a reappraisal of the economic outlook alongside an orderly reversal of overly compressed asset price risk premia. Euro area bank fundamentals are solid, thanks to the strength of banks' capital and liquidity buffers under stringent regulation and supervision. At the same time, continued improvements in asset quality and profitability are contributing to bank resilience. But there is no room for complacency. Bank liquidity challenges could yet intensify. Rolling over maturing bonds is pushing up banks' market funding costs, while competition for deposits is likely to rise and translate into faster deposit repricing. Haircut and margining risk has also increased due to higher volatility in government bond markets. Muted economic growth and signs of weakening credit quality pose downside risks to bank earnings. The outlook for banks has thus become more uncertain, with liquidity asset quality concerns surfacing. The non-bank financial sector could also see such risks. While this sector has remained resilient during the recent banking sector stress and market volatility, its exposure to liquidity and credit risks remains high. If investment funds were to experience any sudden liquidity needs, they could amplify adverse market dynamics via procyclical selling behaviour and forced asset sales, thereby introducing risks to wider financial stability. Strains in the non-bank sector, which is an important source of bank funding, could also give rise to additional banking sector vulnerabilities via liquidity and credit risk spillovers. Past events, such as the pandemic-related turmoil in March 2020 and the UK gilt market stress in the autumn of 2022, also vividly illustrate how non-banks can amplify margin call dynamics in the wider financial system, especially when coupled with excessive leverage. On the side of the non-financial sector, the improvement in macroeconomic developments I noted at the outset have provided key support. At the same time, our assessment underpins how tighter financial conditions are testing household, corporate and sovereign resilience. A strong labour market with unemployment at historical lows has supported household income. But higher interest rates and the squeeze in real income due to high inflation are increasingly compromising household debt servicing capacity. This is reflected in an increase in consumer loans classified by banks as suffering a significant deterioration in credit quality. Robust revenues and high profit margins have contributed to strong corporate results. But firms are also being challenged by tighter financing conditions and the repercussions in terms of the availability and cost of funding. Euro area firms have benefited from high profits on the back of a sharp post-pandemic recovery and lower energy prices. Yet not all firms have benefited equally from the recovery. Highly indebted, energy-intensive and pandemic-sensitive sectors have often been unable to increase profit margins. Adverse developments in the corporate sector would have knock-on effects on bank balance sheets and household employment prospects. Turning to sovereigns, short-term fiscal pressures remain contained. But medium-term challenges are adding to financial stability risks. Fiscal fundamentals remain fragile in some euro area countries, given their high debt levels, rising funding costs and high short-term refinancing needs. As government bond yields have increased sharply across the euro area, higher funding costs will ultimately weigh on sovereigns. At the same time, higher than expected deficits combined with lower growth are limiting fiscal space and may put debt dynamics on a less favourable path, especially in countries with high debt levels. In view of all of the above vulnerabilities, it is clear we are seeing a general turning of the financial cycle. This is also becoming increasingly evident when looking at the euro area real estate sector. A clear downturn is visible in commercial property markets, while after several years of expansion, signs of correction – albeit far less pronounced – are also now apparent in the residential property market. While an orderly price correction in residential real estate might be warranted, a disorderly fall in prices would pose systemic risks. Rising interest rates on new mortgage lending would increasingly compromise affordability and add to the interest burden on existing mortgages, especially in countries where variable-rate mortgages predominate. At the same time, valuations have continued to decline in commercial real estate markets in the euro area. An even more pronounced adjustment in such markets could expose structural vulnerabilities in some open-ended property funds, increase credit risk for lenders and lower collateral values. Let me conclude. Against the background of low growth, high inflation and rising interest rates, signs of a turn in the financial cycle are clearly emerging. As the likelihood of financial stability risk materialising has increased, the Financial Stability Review notes that, in the light of elevated uncertainty amid accumulated vulnerabilities and a turning financial cycle, macroprudential policy should continue to focus on ensuring the resilience of the financial system. While there are some indications of credit supply tightening, driven by higher risk perception and funding costs, capital requirements are not constraining bank lending, as banks continue to exhibit sizeable capital headroom. In fact, many euro area countries have enhanced macroprudential policies since the pandemic, which has also helped greatly to strengthen bank resilience. Maintaining macroprudential buffers now preserves the ability of authorities to release such buffers in response to potential future shocks and support the supply of key services to the real sector at that time. Turning to the non-bank financial sector, the increasing risks posed by this lightly regulated sector, with strong links to banks, requires a comprehensive macroprudential approach to address structural vulnerabilities, notably in investment funds – especially targeting liquidity mismatches and overall leverage. The stress in US and Swiss banking markets has highlighted structural fragilities and demonstrated the greater speed at which liquidity problems can emerge in the financial sector. At the same time, it has revealed that the incomplete banking union is a source of vulnerability for Europe's banking sector. The lack of a complete banking union still represents a very wide gap in the EU's institutional framework. Thank you for your attention.
Members of the Board of Directors of the Bank of Mauritius First Deputy Governor, Bank of Mauritius of the International Monetary Fund and of the World Bank Representatives of other Central Banks The Chairperson, and the Chief Executive of the Mauritius Bankers Association Chief Executives of banks and financial institutions Members of the Media Distinguished guests Ladies and Gentlemen A very good morning. I am pleased to welcome you at the Bank of Mauritius. At the outset, I wish to put on record the proactiveness we witnessed from the International Monetary Fund, the World Bank, the Bank for International Settlements and other Central Banks with respect to this event. The mere presence of international institutions and Central Banks representatives from across the world testifies both the willingness and interest in the future of money and the role of Central Banks I wish to convey my gratitude to the IMF/World Bank Group Community of Technologists for allowing the Bank of Mauritius the opportunity to host this meeting, the more so that I understand that it is for the very first time that this meeting is being held outside Washington D.C. Ladies and Gentlemen, It is very fitting that the theme for this landmark meeting is "The Future of Central Bank Money in a Digital World". For us as central bankers, preparing for the future means getting everything right, now itself. Central Bank Digital Currencies – CBDCs as we commonly call them - entail much more than mere digital representations of a central bank currency. CBDCs may have critical implications on both domestic and international economic and financial stability. Like it or not, the fact remains that unexpected frictions inevitably emerge when it comes to designing a CBDC or implementing and operating it. Central bankers have their own legitimate apprehensions which drive them to always tread very carefully. Sometimes, even too carefully to the taste of FinTechs or operators of new payment technologies. Cooperation, information and experience sharing among the central banking community are therefore necessary to help address concerns and learn from peers on how to overcome stumbling blocks. One of the major stumbling blocks in my opinion is coming to terms with the notion that a CBDC cannot be a "near-cash" option. It needs to be "cash-like". It needs to be as convenient, safe and trusted as cash, though digital in nature. A CBDC must be construed as a type of payment instrument to be made available to one and all. Hence, it should be working just as efficiently as any other existing mode of payment. Otherwise, adoption and acceptance of the CBDC will become very complex. This is particularly more pronounced in countries with well-established payments systems as end-users may have little motivation to switch to another payment mode. It goes without saying that Industry buy-in and the public's trust are very critical in the CBDC experimentation. As a matter of fact, the success of CBDCs hinges on awareness. CBDC experiments can be subject to various challenges, often unexpected ones. That is why it is critical that central banks collaborate with each other, and with international institutions, as well as with their respective stakeholders for meaningful implementation of CBDCs. Amidst the growth of private payment systems, the incursion of bigtechs in the payment arena and the potential risk of partial displacement of legal tender by private crypto assets, central banks started a few years ago to explore the possibility of the issuance of their own digital currency. The extensive research conducted by International organisations including the Bretton Woods institutions and the BIS have significantly contributed to our understanding of CDBCs. Ladies and Gentlemen, Two weeks ago, the IMF launched its handbook on CBDCs in prelude to an International Monetary Fund panel on CBDC in the context of the 2023 IMF-World Bank Spring meetings. I was delighted to contribute to the panel by showcasing the Mauritius experience, and sharing our experience and lessons learnt. This handbook stands as a beacon for central banks along their journey towards creating and rolling out their respective CBDC. In this ethereal digital environment, a number of central banks have adopted a "wait and see approach" on how CBDCs evolve, both conceptually and in practice. Other central banks have, for their part, been actively working to gauge the pertinence of digital currencies, and understand the challenges and benefits that stem from them. This is the case for the Bank of Mauritius. Shortly after I assumed office in 2020, I deemed that working on the creation of our CBDC, the 'Digital Rupee' was to be one of our key priorities. As a central banker, I need not stress upon the determining role that CBDCs can play, not only in protecting monetary sovereignty but also in assisting central banks and regulatory authorities on the front of AML/CFT. Ladies and Gentlemen, CBDCs have been gaining traction globally. It is reported that 114 countries, representing more than 95 percent of global GDP, are currently exploring a CBDC. While only 35 countries were considering a CBDC in May 2020, today 60 countries are in an advanced phase of development, pilot, or even launch. As of December 2022, all G7 economies have embarked on the elaboration of a CBDC. Project Cedar, which is the FED's wholesale CBDC project, has moved the United States from research into development. 18 of the G20 countries are equally now in an advanced stage of CBDC development. Of those, 7 countries are already in pilot phase. In spite of the number of CBDC experiments being carried out in various geographies, the sum total of insights on CBDCs is limited to the available research done so far, and the few proofs-of-concepts and even fewer pilot projects that have been implemented. To that effect, I mustered technical assistance from the IMF to ensure that our "Digital Rupee" was elaborated in the best possible conditions. I must put on record that the Bank of Mauritius was the first Central Bank to benefit from an IMF technical assistance in this respect. We, at the Bank of Mauritius, have adopted a prudent and cautious approach when we embarked on our CBDC journey. In the preliminary stage, in mid-2020, the Bank interacted with experts from different units of the IMF who provided opportunities to strengthen our team's analytical and technological capability through brainstorming workshops. These laid out an early formulation of a thinking through framework for a potential CBDC for Mauritius. Following this, our team investigated objectives, pain points, use cases, technology, infrastructure, cybersecurity readiness and the Bank of Mauritius' role. Further investigation was carried out on the design choices and the related legal foundations. The Bank also engaged with the private sector assisted by the IMF. The decision has been taken for our CBDC, the Digital Rupee, to be interest free. Additionally, we have decided to adopt a two-tier distribution model to manage potential risks to monetary policy and financial stability. This two-tier model will also ensure that commercial banks continue to be fully-involved in our CBDC journey and that there is no disintermediation of banks in the CBDC distribution. The milestone of our ongoing engagement with the IMF is the drafting of a feasibility study report. The feasibility study allowed the Bank to identify design features that would make the CBDC more attractive in the Mauritian context. In parallel, we identified gaps in our technical knowhow and solicited the support of the technology arm of international institutions and other central banks from the G20 community. We took the decision to set up a sandbox in December 2022 to start experimenting various features. The findings will guide us to craft the Digital rupee based on the Mauritian specificities. We are contemplating the rolling out of our Digital Rupee on a pilot phase, post the sandboxing exercise and finalisation of design attributes of our CBDC, in November this year. Not later than yesterday, the Steering Committee on the CBDC met with banks' representatives along with those from the IMF and our chosen partner for the sandbox. I understand that this session was very interactive as commercial banks had the opportunity to have a better insight of the work undertaken by the Bank of Mauritius. I would here encourage all CEOs of banks to be closely follow developments in this area, and engage with their teams, given the strategic importance of CBDCs. The Bank of Mauritius does not envisage to limit its exploration at the domestic front but is considering the use of CBDC for cross-border transactions as a Phase 2. This may be a solution to current frictions in cross-border payments and a means to achieve the G20 objective for faster, cheaper, more transparent and secure cross-border payments. I am also pleased to share that the Bank of Mauritius has been invited to join a Commonwealth initiative for the promotion of technology and Artificial Intelligence. We are eager to share our experience as regards the development of the Digital Rupee and how CBDCs can help improve customer experience and financial inclusion while allowing for better supervision and oversight. Ladies and Gentlemen, The IMF/World Bank bi-annual meetings, which we are currently hosting in Mauritius, allow us to put the spotlight on all concerns we may have, and discuss the solutions for overcoming existing challenges and anticipating potential ones. It is indeed a preeminent platform whereby technical discussions on topical matters allow central bankers to have candid discussions on the best approaches to be adopted. True it is that the implementation of CBDCs touches the core of central bank mandates of monetary and financial stability and that each country should consider its own requirements and subsequently adapt the design features of its CBDC to ensure the intended policy objectives and specificities are met, while mitigating associated risks. In the new post-Covid global financial architecture that is currently taking shape around us, the potential of the use of CBDCs is, and will be, prominent. It is therefore vital that we are able to adapt ourselves and be ready to act in the most appropriate manner in this new financial architecture. At the Bank of Mauritius, we are already gearing up for this. I have noted that the agenda across the 3 days is a very packed one. But I am certain that what participants will reap in terms of knowledge, experience and sharing will be simply priceless. We are fortunate that eminent subject matter experts from all continents have willingly accepted to put their expertise at the disposal of the central banking community. We are very eager to hear about the participants' experiences on their respective CBDC journeys, not only on the payment system side, but also on the monetary and financial stability sides. The lessons on consumer experience, including challenges and solutions for service delivery will benefit the greater number. Pertinent questions from market players and consumers will keep rising and, as central bankers, it is our duty to reflect on them, and provide meaningful answers. Ensuring strong privacy safeguards while meeting financial compliance rules, who will be able to access sensitive CBDC payments data and for what purpose, are some of the questions which we currently face and need concrete answers to. My call to all participants is to make the most of this opportunity for interacting with peers, sharing experiences and working together to devise the best possible approach for the elaboration and roll out of CBDCs. Before I end, I would like to reiterate the need for close collaboration between participants, stakeholders and the public in general. Next month, the Bank of Mauritius will be issuing a document for public consultation on CBDC. I encourage all stakeholders concerned to be fully involved in the discussions and share their views. I wish you all a fruitful workshop. Ladies and Gentlemen, I thank you for your attention.