In view of the progressive global integration of financial and capital markets, capital mobility and the international links between financial intermediaries, central banks must cope with the challenge of securing financial stability. Financial stability is not just a prerequisite for the effective implementation of monetary policy via the transmission mechanism of banks and financial systems; financial stability also provides the corporate sector with a reliable setting for planning and enhances businesses’ propensity to invest and innovate.
In accordance with Article 105(5) of the Treaty, the ESCB contributes to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system.
Central banks must have reliable up-to-date information about financial and capital markets as well as financial intermediaries to be able to recognize and react in a timely manner to any financial market destabilization, such as financial crises. To this end, the ECB and the Eurosystem systematically monitor cyclical and structural developments in the banking sector of the EU and in other financial sectors, with a focus on:
- any systemic weaknesses of the financial sector, and
- its resistance to potential shocks.
In assessing these factors, the ECB cooperates with the EU national central banks and the supervisory authorities. Within the ECB, the financial stability monitoring entails extensive involvement by several business areas (Financial Stability as coordinator, Economics, Operations, International and European Relations and Payment Systems).
”Financial stability” denotes the state in which a financial system is capable of absorbing shocks without triggering cumulative processes that hamper the provision of savings for investment and the smooth processing of payments in the economy. Hence, the monetary policy strategy, consisting of economic analysis and monetary analysis, aids the assessment of the risk of excessive borrowing, which affects financial stability and may cause bubbles to arise. In addition, monetary analysis provides information about anomalies in the financial environment as a whole. The interaction between the household and nonfinancial corporation sectors in an economy the size of the euro area is crucial for the analysis and projection of economic developments. It is also essential to keep tabs on portfolio changes in household net lending/borrowing and its links to interest rate movements and investment in housing. Moreover, it is important to understand shifts between internal and external finance in the financing of nonfinancial corporations, as well as corporate investment and profitability.
The importance of this analysis should be seen against the background of the ongoing integration of European financial markets, which has accelerated in the wake of the introduction of the euro and the single monetary policy. More integration is tantamount to closer links between financial institutions, markets and market infrastructure. Greater liquidity and highly integrated financial markets may reduce the probability of systemic shocks. However, any shocks that may occur will also be more likely to extend beyond national borders, which also means that they could become large enough to present a systemic risk for the entire euro area.