Christian Noyer: Central banks in the financial crisis Speech by Mr Christian Noyer, Governor of the Bank of France, at Paris Europlace, Paris, 3 July 2009. *  *  *  Introduction Ladies and gentlemen, It’s a great pleasure for me to address such a distinguished audience. From the outset, central banks have been major actors in fighting the financial crisis. Overall, their actions have been broadly applauded. In the period to come, however, steering the economy in an environment of high uncertainty will prove particularly challenging. It is therefore timely to reflect upon the past, present and future course of central banks' actions. Today, I would like to address three questions: Is monetary policy responsible for the crisis? How to assess the policy response from the central banks up to now? And, finally, to which extent does the crisis change our vision of their role in the future? Is monetary policy responsible for the crisis? To those who think it is the case, the standard argument goes as follows: in the aftermath of the equity bubble that burst in 2000, interest rates have been kept too low for too long. This created, for investors, both an incentive and a possibility to take excessive risk. The incentive came from the low level of interest rate where the "search for yield" could only be satisfied by moving to riskier assets and increasing leverage. The possibility was created by ample liquidity and the availability of cheap financing.
The pressure on interest rate margins will remain strong as long as interest rates remain exceptionally low. Thus, there will be strong incentives for banks to take on more risk. In the short term, an increase in affordability risk or interest rate risk may help to prevent a further decline in profitability. However, it would make banks more vulnerable to a large upward interest rate shock and to a correction on the mortgage and real estate markets. Greater risk-taking in lending could also lead to a renewed increase in momentum on the mortgage and real estate markets. This applies particularly to residential investment property, where upward pressure on prices could remain strong. If interest rates rise, there is the risk of a substantial price correction. This could result in credit losses at the banks that provide funding for such investors. This highlights the importance of the capital surpluses currently held by the domestically focused banks. Going forward, banks should set their risk appetite and their capital planning so as to ensure that they can absorb the losses that would arise under highly unfavourable but possible scenarios. Even under such scenarios, the banks must be able to perform their economically important functions – especially that of providing credit to the economy. The SNB will continue to monitor developments on the mortgage and real estate markets closely, paying particular attention to the residential investment property segment as well as to banks’ risk-taking in mortgage lending.