Draghi, Letta: All Eurozone countries must be able to borrow like Germany

Mario Draghi, President of the European Central Bank (on the left) and Ollie Rehn, Vice President of European Commission, responsible for financial affairs and the euro. (EC Audiovisual Services).

The reduction of European Central Bank’s basic rate from 0.75% to 0.5 % was the less important news from Bratislava, Slovakia, yesterday where the governor of the central bank, Mario Draghi, presented the decisions of the bank’s Governing Council and answered questions from journalists. Not even the possibility of a new interest rate cut soon was of much importance in what Draghi said. This last prospect also has been discounted by markets.

The European Sting had not only predicted yesterday’s interest rate cut, but had commented that historically it was the first time that the ECB had almost pre-announced it. The strong dynamic in this affair could not be consumed in a quarter unit interest rate cut and seemingly there will be a new one soon.

However all that are of less importance compared to what Draghi had to say about the real economy and the role of ECB. Diverging strongly from the German tradition of Bundesbank, Draghi expressed a strong interest for the countries under stress and the Small and Medium Enterprises (SMEs). Bundesbank’s influence on ECB had up to now restricted and almost immunised central bank’s action from real economy issues, focusing it exclusively on monetary and financial markets. Now Draghi shows a vivid interest in real economy and its backbone, the small and medium-sized enterprises (SMEs).

Focus on the real economy

His comment on that was very characteristic. He said “The recent Bank Lending Survey (BLS) confirmed weak demand for loans in the euro area. While some signs of stabilisation are emerging, the Survey on the access to finance of  (SMEs) in the euro area indicates continued tight credit conditions, particularly for SMEs in several euro area countries. Moreover, the available information indicates high risk perception on the part of banks”.

After the SMEs, Draghi went on showing a vivid interest for the countries under stress. He said that, “In order to ensure adequate transmission of monetary policy to the financing conditions in euro area countries, it is essential that the fragmentation of euro area credit markets continues to decline further and that the resilience of banks is strengthened where needed. Progress has been made since last summer in improving the funding situation of banks, in strengthening the domestic deposit base in stressed countries and in reducing reliance on the Eurosystem as reflected in repayments of the three-year LTROs. Further decisive steps for establishing a banking union will help to accomplish this objective”. Let’s analyse all that.

ECB’s policy out of frame

There are two points of interest in what Draghi said. First he observes that there are “continued tight credit conditions particularly for SMEs in several euro area countries”. Unquestionably he means that the SMEs in stressed Eurozone countries like Italy, Greece, Spain, Portugal, Ireland and elsewhere are being starved of financial support because banks avoid taking more such risks. In view of that he says, “In order to ensure adequate transmission of monetary policy to the financing conditions in euro area countries, it is essential that the fragmentation of euro area credit markets continues to decline further and that the resilience of banks is strengthened where needed”.

Given that Ollie Rehn, the vice President of the European Commission, was present yesterday in the Bratislava meeting of ECB’s governing Council, Draghi in this above quote goes as far as to make political policy proposals, that only Rehn is competent to   formulate. This Commissioner however speaking in the European Parliament last week acknowledged that there is now a pressing need for more growth measures to be applied in Eurozone. It was the first time that Rehn, the architect of the severe austerity programmes, spoke of relaxation. Seemingly Draghi got the message and wanted to give financial substance to Rehn’s opening of a new policy horizon.

In short Draghi concluded that the fragmentation of Eurozone’s financial market must be effectively addressed, in order ECB’s policy of cheap money to reach everybody and the resilience of peripheral banks be strengthened. Those are not easy tasks though. In order to support the resilience of peripheral banks so as they can take care of the financial needs and the risks of the SMEs, there is only one way to do it; recapitalise the lenders adequately. As for the defragmentation of Eurozone’s financial markets this is an even more difficult task because it presupposes the successful application of the governments programmes towards zeroing their fiscal deficits.

Letta plus Draghi

Try to recall what the new Italian Prime Minister, Enrico Letta, said to German Chancellor Angela Merkel, about the target of running a balanced budget in Italy. He said that this is more or less destined to happen next year given as it is foreseen by the Constitution. In reality the same is true for Greece and Ireland. Letta is worried though about what is to follow after the zeroing of fiscal deficits. Then what?

The consolidation of the government budgets does not mean necessarily that the national peripheral financial markets will start automatically working like Frankfurt or Paris, lending money to SMEs at comparable interest rates as in Germany in a unified Eurozone financial market. As a matter of fact Draghi came to answer that, knowing very well that in order to defragment Eurozone’s financial markets and strengthen the resilience of the peripheral banks they have first to be recapitalised.

This can be done either by public means like the EFSF/ESM or the markets. But in order to arrive at a situation where the world markets will start again trusting the Greek and the Portuguese banks, the ECB must guarantee the trustworthiness of those peripheral lenders. This will be done under the new ECB’s role of supervisor of Eurozone’s banking system, in the environment of the Banking Union. Then Draghi made another revelation by saying that, “the Governing Council emphasises that the future Single Supervisory Mechanism and a Single Resolution Mechanism are crucial elements for moving towards re-integrating the banking system and therefore require swift implementation”.

This is exactly what Letta asked for in Berlin and Paris; the enactment of the Banking Union the soonest possible. In reality Draghi arrived at the same conclusion with the new Italian Premier or possibly the other way around. The fact remains that from now on the ECB, under Mario Draghi, will push hard towards enacting the Banking Union and help the peripheral countries regain what they had until 2008; borrowing at the same interest rates as Germany.