Abstract
Despite a long history of program engagement, the Fund has not developed guidance on program design in members of currency unions.
Policy Framework of the European Union Institutions
Following the issuance of the Board paper on “Program Design in Currency Unions” (SM/17/237), staff has continued a dialogue with the European Union authorities over aspects of their policy framework that are germane to the topic of the paper. In light of these discussions, this supplement elaborates further on the governance of EU institutions, the ECB’s monetary policy framework and operations, the role of Target 2 in the Eurosystem, and relevant aspects of the supervisory framework within the banking union. This supplement does not affect the staff’s policy proposals in SM/17/237.
1. The legal independence of the ECB. While the staff paper emphasizes that the proposed approach regarding policy assurances from union-level institutions would in no way infringe upon the legal or operational independence of such institutions, in discussions with staff the euro area authorities highlighted the legal constraints which their institutions—notably the ECB—must observe. In particular, the euro area authorities have emphasized the following:
The Treaties governing the EU and the euro area assign specific responsibilities to its supra-national bodies and explicitly enshrine the independence of some of those bodies. The union-level authorities pursue common policies such as monetary, supervisory, or competition policy which cannot be altered with respect to an individual Member State without affecting the independent mandates of the respective institutions to provide a consistent legal and institutional framework for all 28 EU members as enshrined in the EU Treaties. Those common policies are outside the direct and indirect control of the respective country authorities.
In this context, the ECB’s independence is a cornerstone for the effectiveness of the ECB’s mandate. Article 130 of the Treaty on the Functioning of the European Union (TFEU) contains a double prohibition to safeguard this independence. First, the ECB/Eurosystem is prohibited from seeking or considering instructions from any other body, inside or outside the union. Second, EU institutions and the governments of EU Member States undertake not to seek to influence the members of the ECB’s decision-making bodies in the performance of their tasks. Independence enables the ECB to define and implement a “single monetary policy” in pursuit of its primary objective of maintaining price stability in the euro area without any adverse influence from the various national decision-makers that exercise national or shared sovereignty in several policy domains within the euro area.1
The ECB also enjoys independence in the exercise of its supervisory tasks. This is reflected in Article 19 of the Council Regulation 1024/2013 conferring specific tasks on the ECB concerning policies relating to the prudential supervision of credit institutions. The nature of the ECB’s implementation of supervisory policies gives the ECB scope, when deemed necessary, to voluntarily provide information related to its supervisory policies, with or without emphasis on selected jurisdictions. Indeed, micro-prudential policies have played a central role in adjustment programs within the euro area. The ECB stressed, however, that it reserves the right to modify the initially defined policy approach should it see a need to do so, for example, in light of changing circumstances. Any ECB decision in the field of supervision, including modalities for the communication of policy intentions in the area of micro-prudential supervision, must be determined in line with ECB decision-making procedures.
In view of the above, the provision by EU supra-national bodies of any type of policy assurances has to be in line with the requirements of their legal framework—notably legal independence.
2. The monetary policy framework of the Eurosystem. In discussing the circumstances under which the Fund would seek assurances regarding actions by union-level institutions in support of a member’s program, the staff paper draws a distinction between actions that would have effects limited to a specific country (certain supervisory actions, for instance) and those that would have union-wide impact. The euro area authorities have emphasized that there are various aspects of the ECB’s operational framework that ensure adherence to the principle of a single (union-wide) monetary policy, and highlighted the following points:
In the Eurosystem—consisting of the National Central Banks (NCBs) of the euro area countries and the ECB—decisions on monetary policy are made at the level of the Governing Council of the ECB. The common monetary policy is generally implemented at the level of the individual NCBs, according to the decisions made and guidelines laid down by the Governing Council and under coordination by the ECB.
The Governing Council of the ECB formulates monetary policy for the euro area as a whole and decides on all related implementation modalities.2 In particular, the Governing Council agrees on the common collateral and counterparty eligibility framework and decides on non-standard monetary policy measures such as Fixed Rate Full Allotment (FRFA) in liquidity-providing operations,3 and asset purchase programs, the Eurosystem’s form of quantitative easing (QE).
The ECB’s monetary policy operations are conducted only with financially sound euro area credit institutions against adequate collateral. The Governing Council ensures a level playing field, i.e. that every credit institution within the euro area can receive central bank liquidity on the same terms, including the definition of eligible collateral for monetary policy operations. The ECB modified the collateral requirements during the euro area financial crisis in line with emerging needs to ensure the smooth functioning of the monetary policy transmission mechanism. The authorities highlighted in this context that the waiver of rating requirements for collateral is a rule, not a discretionary measure, and it applies to any euro area government that meets the criteria (i.e. if the government is under a program and on track with it, then rating requirements are waived for assets issued or guaranteed by it) and to any monetary policy counterparty (i.e. any counterparty can use as collateral any asset issued by a government to which a rating waiver applies). The Eurosystem does not provide credit to any government body, as such operations are prohibited as constituting monetary financing, in accordance with Article 123 of the TFEU.
The Governing Council conducts monetary policy in pursuit of its mandate under EU law to maintain price stability in the euro area as a whole. ECB monetary policy decisions are based on euro area wide developments and the euro area outlook for price stability in the medium term, not on developments in any specific country. This implies that the setting of monetary policy cannot be changed for the benefit of a single country or be applied only to a single country.4
There is also no leeway for an NCB to deviate from the single monetary policy setting. The balance sheet of an NCB largely reflects the implementation aspects of the single monetary policy instruments (lending operations, asset purchases) and does not provide any leeway in conducting monetary policy. Also, non-monetary policy activities of NCBs are subject to decision and guidelines laid down by the Governing Council and monitoring by the ECB, in particular to ensure that non-monetary policy activities do not interfere with the objectives and tasks of the Eurosystem.
The costs, gains and risks from the single monetary policy can be shared among the Eurosystem on the basis of a Governing Council decision. Monetary policy operations are booked on the balance sheet of the NCB or the ECB conducting the transaction. The reserves held by the banking system are booked on the balance sheet of the NCB where the respective credit institution is located.5 The income accruing to the NCBs in the performance of the monetary policy lending operations is pooled and then distributed to the NCBs in line with their capital key.6
Based on national mandates, and not as part of the single monetary policy of the Eurosystem, NCBs may exceptionally provide emergency liquidity assistance (ELA) to credit institutions that are in need of liquidity.7 ELA is understood as the provision of central bank money to individual solvent financial institutions that are facing temporary liquidity problems.8 The provision of ELA must be sufficiently collateralized, although the standards (e.g. regarding collateral quality and haircuts) may differ from those applied in monetary policy operations.
While the responsibility for the provision of ELA lies at the NCB level, the Governing Council can object to any such operation if they find that it would interfere with the Eurosystem’s objectives and tasks. This could, for example, be the case if ELA was deemed to interfere with the price stability objective or the definition and implementation of the (single) monetary policy in the euro area. ELA is recorded on the balance sheet of the respective NCB. Any costs and risks arising from the provision of ELA are incurred by the NCB concerned.
3. TARGET2 and the balance of payments of euro area countries. The staff paper describes the general approach the Fund would take, for program purposes, to assess the balance of payments need of countries that are members of currency unions. The euro area authorities have reiterated that a number of considerations would need to be taken into account when applying this approach in the particular context of the euro area. They have made the following points:
TARGET2—a real-time payment system for processing large-value, euro-denominated payments in central bank money (i.e. banking system reserves)—is integral to the monetary union, as it ensures that the liquidity of banks held with the Eurosystem is fully fungible across euro area member countries. As long as all payments in central bank money are made between domestic accounts, only accounts at the NCB concerned are affected. The TARGET balance of that NCB vis-a-vis the ECB will remain unchanged. If cross-border central bank money payments are made in the euro area, the accounts of two NCBs will be affected and accordingly also their respective TARGET balances vis-à-vis the ECB.
In other words, the Eurosystem’s monetary policy operations may have an impact on a Member State’s balance of payments via TARGET balances only if the injected liquidity is used for cross-border payments. At the time of liquidity provision via credit operations (both Eurosystem refinancing operations and ELA), the liquidity provided by the NCB is credited to the account at the NCB held by a bank domiciled in the NCB’s jurisdiction. No cross-border payment occurs and TARGET balances are not affected. Only if banks transfer these funds abroad (on their own behalf, e.g. to repay cross-border loans, or on behalf of customers) may changes in TARGET balances arise. In contrast, unconventional monetary policy operations such as the Asset Purchase Program (APP) can be associated with direct cross-border payments upon implementation. NCBs purchase securities (with Governing Council-decided volumes and conditions), which can affect TARGET balances to the extent that the counterparty in the transaction with the NCB is a non-domestic one. Subsequent portfolio rebalancing by underlying sellers can also give rise to cross-border payments and changes in TARGET balances. Purchases of securities under the APP by the ECB itself may also have cross-border impacts.
In the “standard” presentation for statistical reporting under BPM6, all cross-border flows of central bank money, as reflected in changes in TARGET balances, are recorded in the balance of payments (BoP) of euro area countries.9 These flows appear as part of “other investment” in the financial account under the item “other investment—national central bank.”10 According to BoP accounting (equation 1, below), a euro area country’s current account (CA) deficit (surplus) with the rest of the world is matched by private and/or official net financial inflows (outflows) denoted by FA, where the latter include changes in the NCB’s TARGET balance (ΔTARGET) and flows of the general government (OTH(GOV))— for instance, those related to EU/IMF financial assistance programs.11
CA = FA(private) + FA(official) + Residual (1)
Balance of payments financing needs in euro area member states manifest themselves in a net drain of funds out of the country from either the private or the public sector (reflected in financial transactions between residents and non-residents). This is the case regardless of whether the drain is in foreign or domestic currency, or to countries inside or outside the currency union. In countries outside a currency union, a balance of payments crisis usually manifests itself when the country’s current account deficit is no longer fully compensated by financial account (including official reserve) net inflows, with the currency typically losing value vis-à-vis other currencies. In the euro area, where part of the official foreign exchange reserves are pooled with the ECB and where the exchange rate is common, the external value of the euro will be influenced by the combined position of all euro area residents and could thus move independently of the BoP problems in one of the euro area countries.12 If a net drain of funds in a euro area country is associated with a reduction in the availability of funding for banks in that country, these banks may, under certain conditions (e.g. availability of adequate collateral), obtain liquidity via Eurosystem refinancing operations or ELA.
BOP movements related to TARGET balances may have several sources, many of which are not related to a crisis-related net drain of funds. Changes in TARGET balances must be mirrored in any of the other BoP components, in accordance with equation 2, below. This is true whether the liquidity used to fund the underlying cross-border payments is sourced from existing balances at the NCB, through interbank markets, or via monetary policy operations, and whether that liquidity is demand-driven (when banks obtain central bank liquidity in exchange for collateral) or supply-driven (when the Eurosystem provides central bank money in exchange for securities):13
ΔTARGET = CA — FA(private) — OTH(GOV) — Residual (2)
Under certain circumstances ECB policy measures may have a de facto stabilizing impact on a euro area country’s BoP. For example, a detailed analysis of cross-border transactions in the period from mid-2011 to mid-2012 shows that the emergence of TARGET balances was partly related to the collapse in private financial inflows. The increase in TARGET balances was thus associated with a replacement of private sector funding of banks by central bank funding in a period of stressed bank funding conditions. During this period a substantial part of the liquidity provided by the Eurosystem to the euro area banking system was used by banks in stressed euro area countries for cross-border transactions, which led to an increase in TARGET liabilities and may have supported the BoP in these countries.
Large changes in TARGET balances may, however, also occur as a by-product of monetary policy implementation in the absence of any crisis-related external flows in the balance of payments. The APP, which started in March 2015, has also coincided with rising TARGET balances. However, this period has not generally been characterized by crisis-related BoP developments in the formerly-stressed euro area countries. The increase in TARGET balances during this period is largely attributable to the interplay between the decentralized implementation of the APP and the financial structure of the euro area, as well as subsequent portfolio rebalancing. The net portfolio investment outflows observed during this period did not reflect crisis-induced external flows associated with sudden stops or capital flight, but rather constituted portfolio rebalancing towards foreign assets, as observed across the euro area, which is a standard reaction to QE operations. Hence, large changes in TARGET balances are not, per se, an appropriate indicator of crisis-related developments in the balance of payments of a euro area country.
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The above analysis provides useful detail regarding the legal, institutional, and policy frameworks that underpin the mandate of the EU institutions. From the staff’s perspective, this material does not affect the policy proposals in the main staff paper (SM/17/237). In particular, as is the case with all Fund-supported programs, it is understood that any assurances provided by a central bank regarding its policy intentions are entirely voluntary and, moreover, must be consistent with the legal framework that underpins the mandate of the central bank in question. Indeed, safeguarding the independent decision-making of central banks has long been regarded by the Fund as a vital element in securing members’ internal and external balance, and hence international monetary stability.
The Court of Justice of the EU has confirmed that, when implementing its monetary policy, the ECB/Eurosystem must be allowed “broad discretion” so as to ensure that it fulfils its mandate under the Treaties to define and conduct a “single monetary policy.”
The Governing Council consists of the governors of the NCBs participating in the euro area together with the six Executive Board members of the ECB. The members of the Governing Council are mandated in their personal capacity and do not represent a country. The decision-making of the Governing Council takes place in full independence.
Under FRFA, counterparties can receive at a fixed main refinancing rate as much central bank liquidity as they wish against eligible collateral. FRFA does not apply to Targeted Longer-term Refinancing Operations (TLTROs) for which counterparty-specific limits are set.
The authorities stressed that, while monetary policy can have a balance of payments impact (see next section), it is never implemented by the ECB with the intention to target balance of payments movements or needs, as these are not part of the ECB’s mandate.
Credit institutions interact with the NCB with which they have an account. The ECB does not hold monetary policy accounts of credit institutions.
The Eurosystem is obliged to publish a weekly consolidated financial statement.
The complete ELA agreement can be found on the ECB website: https://www.ecb.europa.eu/pub/pdf/other/Agreement_on_emergency_liquidity_assistance_20170517.en.pdf?23bb6a68e85e0715839088d0a23011db.
This may be the case if a credit institution does not have sufficient eligible collateral at its disposal to participate in monetary policy operations or is suspended/limited/excluded from these operations, e.g. on the grounds of prudence from an ECB risk management perspective.
A detailed explanation of TARGET balances can be found in The Eurosystem’s asset purchase programme and TARGET balances (2017), ECB Occasional Paper No. 196, Jens Eisenschmidt, Danielle Kedan, Martin Schmitz, Ramón Adalid and Patrick Papsdorf.
From the Fund’s perspective, under the “analytical” presentation of the BoP (BPM6, Chapter 14 and Appendices 1 and 9), a distinction is made between autonomous above-the-line items and below-the-line “exceptional” financing items. The analytical presentation of the BoP is instrumental for determining the BoP need in Fund operations. It distinguishes between above-the-line transactions that are deemed ‘autonomous’—those “undertaken for the sake of the transaction”—and below-the-line items that are considered to be accommodating or financing the deficit. Below-the-line exceptional financing “brings together financial arrangements made by the authorities (or by other sectors fostered by the authorities) of an economy to meet balance of payments needs. These transactions can be viewed as an alternative to the use of reserve assets, IMF credit and loans to deal with payments imbalances or in conjunction with such use.”
The other items (i.e. errors and omissions, the capital account and reserve asset flows) are included in the residual category in equation (1)).
From the statistical reporting perspective (BPM6), “reserve assets must be foreign currency assets” (i.e. claims on non-residents of the currency union). By contrast, from a Fund law perspective, in a reserve-issuing currency union such as the euro area, holdings of euro reserves have both a “foreign” and “domestic” currency character to euro area members, as noted in the main paper.
The residual also includes net flows in other investment of the NCB which are not changes in TARGET balances.