ECB’s Schnabel Says Bank-Government Dependence Can Boost Growth

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European Central Bank Executive Board member Isabel Schnabel said the mutual interdependence of banks and governments can boost economic growth after the pandemic -- in contrast to the bloc’s sovereign debt crisis when it was seen as fundamental problem.

“Contrary to the vicious ‘sovereign-bank’ nexus that plagued the euro area throughout most of the last decade, the current nexus, if managed properly, can be an engine for a faster recovery, which also supports the ECB’s price-stability mandate,” she said at online conference on Thursday.

Such a view is a departure from years of trying to break the mutual reliance of governments and banks on each other. During the last euro-zone crisis, investor doubts over the sustainability of government debt plunged lenders intro trouble as their bond holdings collapsed in value. That in turn required bailouts that further strained public finances.

Schnabel said that for now, the broad monetary and fiscal support to banks that enables them to continue lending will limit scarring, aiding the rebound when the crisis passes.

Still, she also warned against letting the same interdependencies turn into another self-reinforcing meltdown. That could happen if public support such as loan guarantees and company aid are withdrawn too soon -- with consequences for the ECB’s mandate.

“Governments need to be mindful of cliff effects that might set off a vicious circle of corporate defaults, tighter bank lending conditions and growing sovereign vulnerabilities,” she said. “Increasing corporate defaults through a premature withdrawal of fiscal support would deepen the contraction in output and, ultimately, exert additional disinflationary pressures.”

The ECB’s supervisory arm urged banks on Thursday to do a better job of gauging the risks the face amid the pandemic. The full scale of distress in their loan books might not yet be fully visible as the economy continues to deteriorate, it said.

Governments dramatically boosted their debt burdens last year to keep companies and jobs afloat during pandemic lockdowns. A substantial chunk of that has landed on the ECB’s balance sheet, after policy makers launched an emergency bond-buying program in March.

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