Second, the imposition of such an additional capital requirement may also inhibit the expansion of banks’ balance sheets, so dampening the upswing of the credit cycle. This second mechanism obviously requires the Modigliani-Miller theorem to fail, in the short run at least; if it doesn’t then there is no reason for a bank’s management to prefer debt finance to equity finance. Now the most obvious reason why the Modigliani-Miller theorem fails for banks is the implicit subsidy to debt finance that comes from being “too big (or too complex) to fail” so that taxpayers, rather than creditors, pick up the tab if capital is insufficient to absorb losses. Recent and prospective regulatory reforms seek to reduce the too big/too complex to fail problem, but eliminating it entirely may be an aspiration too far. Moreover, there are likely to be other frictions to raising capital which mean that raising capital requirements will inhibit balance sheet growth, providing traction for the countercyclical capital buffer. However, this is an area where empirical evidence is in relatively short supply (though for some examples, see: Macroeconomic Assessment Group, 2010; and Aiyar et al., 2012). The second tool is the ability to vary capital requirements by type of asset, allowing the FPC to target excessive exuberance in specific sectors. The EU will permit national authorities such discretion in regard to residential property, commercial property and intra-financial sector exposures.
PART 1: The main features of the Eurosystem monetary policy strategy Let us see what are the main features of the single monetary policy, conducted by the Eurosystem, in terms of institutional and operational framework as well as on strategic issues themselves. 1. The institutional and operational framework is founded on modern concepts Let me recall first that over the past decade, a large body of literature has been devoted to questions surrounding central bank independence, the concepts of transparency and monetary strategies, and the communication of monetary policy decisions. Drawing on this analytical expertise and the experience of the national central banks of the participating countries, the Eurosystem is first and foremost based on a modern institutional framework, founded on the principles of independence, transparency and accountability and, lastly, operational decentralisation. 1.1. The independence of the Eurosystem fosters price stability The Eurosystem’s primary objective, as enshrined in the Maastricht Treaty, is to achieve and maintain price stability. As many empirical studies have shown, a country’s ability to fight inflation appears very closely correlated to the degree of independence of its central bank. The independence of the European Central Bank and the 12 national central banks of the Member States of the euro area is therefore anchored in the Treaty. In operational terms, this means that, in the conduct of their duties, neither the European Central Bank nor the national central banks of the Eurosystem may request or take instructions from the Community institutions, national governments or any other body.