At the Banque de France and the ECB we have been conducting extensive listening exercises and the issue has been frequently raised by the general public. Moreover, to what extent financial stability concerns should figure in monetary policy decisions is a perennial debate. Most central banks have a separation principle in which monetary policy and financial stability, to be dealt with by macroprudential policy, are kept entirely distinct. This clear division of responsibilities has worked well but I think recent developments have tipped the balance in favour of more integrated approach. First, we are no longer in a linear world. When r* is very low, there is a fundamental asymmetry created by the effective lower bound on interest rates. We have created substitute instruments to compensate for the impotence of conventional monetary policy at the effective lower bound but these instruments, although still effective, have some adverse side effects on excessive risk taking. Second, the macroprudential instruments we actually have, while remaining the first and main line of defense, are insufficient to address the whole range of financial stability concerns. We should not be Panglossian, in the phrase of Charlie Bean vii. Consequently we must accept that financial stability concerns have to be a factor in the setting of other instruments, and in particular monetary policy. This is the more integrated approach that I want to plead for. This does not imply a systematic (mechanical) reaction to financial stability indicators, and it is very different from the leaning against the wind strategy.
However, in contrast to the uncertainties created by securities valuations in 2008 and 2009, banks should largely be in good positions to forecast the loan losses facing them, using their internal models, and they should thus be in a better position to manage the potential future write-downs without unexpected capital shortages. The second risk that we have identified within the euro area financial system relates to vulnerabilities of financial institutions associated with concentrations of lending exposures to commercial property and to Central and Eastern European (CEE) countries. You may recall that, in the December issue of the FSR, we drew your attention to these two types of exposures. Since then, in the commercial real estate sector, prices and rents have continued to fall in most euro area countries, although at a moderating pace. Reflecting this deterioration, estimates of losses facing banks on their commercial property loan portfolios had been revised upwards by almost 50% over the past six months, as shown in Chart 7 on slide 12, and concerns remain about concentrations of such exposures among some euro area banks. This increase in estimated losses on commercial property loans is expected to more than offset the recovery in the valuations of commercial mortgage-backed securities held by banks in the euro area. As regards banks’ exposures to the CEE region, since December, the economic outlook in the region has improved.