BIS central bankers’ speeches  5  Given the importance of addressing the risks stemming from systemically important financial institutions, it is necessary for regulators to reduce and if possible eliminate the prospect that a systemically important financial institution would find itself in difficulties in the first place. This consideration also brings up the need of supervising better shadow banking,5 which consists of those parts of the financial system that are not visible to regulators and hence not under their direct control and supervision.6 Basle III goes a significant way in narrowing the gaps in regulation that result from recourse to shadow banking.7 It does so by incorporating off-balance sheet exposures in the leverage ratio and by including in the liquidity, regulatory and supervisory standards a range of risks stemming from shadow banking. Thus, stronger banking regulation and supervision will go a long way towards containing the risks of the shadow banking sector. The situation in Malta I will now take a closer look at some key issues relating to the domestic economy and financial system, particularly the fiscal situation, international competitiveness and financial stability. The outlook for the fiscal situation calls for continued vigilance and caution. Official projections of the deficit ratio for 2012 and 2013 have been revised downward, remaining below the Maastricht threshold of 3%. However debt forecasts have been generally revised moderately upward, to levels projected above the 70% level in 2012 and 2013.
Government finances were quite healthy, with low public debt and a low deficit to GDP ratio. The turning point came with the collapse of the housing market starting in 2007. A drop in banks’ share prices led to a deposit run on the banks. The scale of the problem snowballed after the Irish government guaranteed all the obligations of the largest banks. This transformed the house price crash into a sovereign debt crisis, with the evaporation of the markets’ confidence in Ireland’s ability to honour its obligations. Irish borrowing costs rose abruptly, requiring an EU/IMF bailout. 4  4  Ioannis Sarmas, ibid. BIS central bankers’ speeches  Strengthening governance As I have already mentioned, the ECB played an important role in the policy response to the crisis. In addition to the conventional interest rate tool, the ECB introduced a number of nonstandard measures (such as the three-year LTROs that I mentioned earlier, and a reduction in the required reserve ratio) to facilitate the transmission of monetary policy to the economy. The events of the last few years have provided important lessons for the construction of a whole new approach to European economic governance. The aim is to go beyond the shortterm responses, such as the Greek bailouts, and tackle the problem before the situation has become critical. To provide better support where necessary, the European Financial Stability Fund will be replaced by the European Stability Mechanism, which will be a permanent rescue fund with added firepower and a stronger mandate.