Luc Riedweg June 1310

Central Banking in the Post Greece Crisis Period

Luc Riedweg GIC Conference, Prague Tuesday, June 14th, 2010

GIC Conference - Prague June 14th

1

Outline



Latest actions of central banks and public authorities to contain the tensions on financial markets



The challenges ahead for the global financial system

Source : Bloomberg.

GIC Conference - Prague June 14th

2

Outline



Latest actions of central banks and public authorities to contain the tensions on financial markets



The challenges ahead for the global financial system

Source : Bloomberg.

GIC Conference - Prague June 14th

3

Sovereign debt tensions  

Bond spread for several euro area countries widened Even less vulnerable Banks countries were affected

Euro area 10Y interest rates during the four stages of the crisis 8%

Systemic outbreak

Financial crisis build-up

Systemic response

Sovereign risk

7%

Germany

France Italy

6%

Spain Netherlands

5%

Belgium Austria

4%

Greece Ireland

3%

Portugal Finland

2% 01/07

07/07

01/08

07/08

01/09

07/09

01/10 Source : Bloomberg.

GIC Conference - Prague June 14th

4

Sovereign debt tensions CDS premia (bp)

Source: Bloomberg

Source : Bloomberg.

GIC Conference - Prague June 14th

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Spot libor-OIS has more than doubled since April 3-month Libor OIS spreads (bp) 60

en bps

50 40

30 20 10 0 07/09

10/09 01/10 04/10 months Spread EURIBOR - swap OIS 3 3mois Spread LIBOR USD - swap OIS 33mois months

Source: Bloomberg

Source : Bloomberg.

GIC Conference - Prague June 14th

6

Public authorities’ response



Securities Market Programme (SMP)



European Financial Stabilisation Fund (EFSF)



ECB/Fed swap dollar facility

Source : Bloomberg.

GIC Conference - Prague June 14th

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The functioning of the market for government bond is central to the transmission of the ECB’s policy rates

Price channel

Liquidity channel

Balance sheet channel

 Government bonds constitute the benchmark for pricing almost all loans to the private sector  When risk premia become too large, the signal from the key policy rates is no longer perceivable and does not reach the real economy

 Government bonds are often used as collateral for banks’ refinancing operations  If government bond markets are disrupted, this hampers the functioning of the interbank market and reduces liquidity in this market

 Lower government bond prices imply valuation losses in the assets held by the financial and non-financial sectors.  For banks, the lower capital base may mean that they can supply fewer loans to the economy.

GIC Conference - Prague June 14th

8

Outline



Latest actions of central banks and public authorities to contain the tensions on markets



The challenges ahead for the global financial system

Source : Bloomberg.

GIC Conference - Prague June 14th

9

Fragile conditions in the EU banking sector

Increase in cost of risk

EUR bn

120

2008

2009

100

80

+46%

+ 40%

60

40

20

0

Europe

USA

Source : Financial reports

GIC Conference - Prague June 14th

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Fragile conditions in the EU banking sector Provisions for non performing loans / Non performing loans 2008

2009

100% 90% 80% 70% 60% 50% 40% 30%

GIC Conference - Prague June 14th

HSBC

RBS

Barclays

UBS

CS

DB

Santander

Source : Financial reports

SG

BNPP

20%

11

Resurgence of interest rate risk Recent steepening of the yield curve  

Upward pressure on interest rates: steepening of the 2Y-10Y spreads What are the main drivers for the upcoming months?

2Y-10Y spread – Bund

2Y-10Y spread – US Treasury 300bp

6%

250bp

5%

4%

200bp

4%

200bp

3%

150bp

3%

150bp

2%

100bp

2%

100bp

1%

50bp

1%

50bp

0%

0bp

0%

0bp

6% Spread 2Y-10Y 2Y 10Y

5%

01/07

07/07

01/08

07/08

01/09

07/09

01/10

01/07

300bp Spread 2Y-10Y 2Y 10Y

07/07

01/08

07/08

01/09

250bp

07/09

01/10 Source : Bloomberg.

GIC Conference - Prague June 14th

12

Expected evolutions of the yield curve Three sources of risk 





Macroeconomic environment 

Improving growth likely to put pressure on returns…



…roughly cancelled out by the low inflation context

Imbalance between supply and demand 

No structural imbalances anticipated between fixed income supply and demand



UK stands for an exception (end of quantitative easing)

Sovereign risk 

Deterioration in the sovereign risk could potentially triggered sharp moves in long term rates



Increasing disparities within the Euro area and, more broadly, at the global level

GIC Conference - Prague June 14th

Low risk

Medium risk

Potentially high risk

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Expected evolutions of the yield curve Downward pressure stemming from low inflation 

A possible impact on long term yields due to the improving macroeconomic environment…



…should roughly be cancelled out by the low inflation context Inflation – Consensus forecast end 2010 and 2011 5%

Consensus 4% 3% 2,6%

2%

2,29%

1,99%

1,22%

1%

1,51%

1,73%

0% 2010

2011

United States

2010

2011

Euro area

GIC Conference - Prague June 14th

2010

2011

United Kingdom

Source : Consensus Economics.

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Banks’ refinancing risk Average maturity and aggregate face amounts of Moody’s rated Euro Area debt issuance

GIC Conference - Prague June 14th

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Realized and Expected Writedowns or Loss Provisions for Banks by Region

GIC Conference - Prague June 14th

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Macroeconomic risks in the Global Financial Stability Map (IMF)

GIC Conference - Prague June 14th

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Sovereign risks: transfer of risks to governements balance sheets

GIC Conference - Prague June 14th

Sovereign risks: increasing borrowing needs

GIC Conference - Prague June 14th

Sovereign risks & main contagion channels

Sovereign debt to GDP in the G7

Sovereign risks and spillover channels

Source : IMF GFSR

GIC Conference - Prague June 14th

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