Opening Remarks by Governor Mário Centeno at the Conference on Financial Stability

Good morning to everyone gathered here and for the ones joining us online.

I welcome you today to the 2023 Banco de Portugal Financial Stability Conference.

It is my pleasure to address such a distinguished audience and our esteemed speakers, who bring a wealth of diverse expertise to engage in deep discussion on matters crucial to financial stability.

Today's conference is dedicated to the overarching theme of "Financial stability: why does economic policy coordination matter?".

In its 5th edition, our aim remains unchanged: to provide a platform for policymakers, academics, and practitioners to engage in substantive discussions on key topics.

Today's discussions will cover monetary policy, fiscal policy, and financial regulation, but also climate change and digitalization. To kick start the discussion, let me point out linkages between monetary and macroprudential policies.

A persistently high inflation may have disruptive effects on households and businesses. The recent ECB Governing Council decisions reflect this concern. High inflation introduces uncertainty into real incomes, requires a firm monetary policy to generate a more predictable economic environment.

The distributional effects of inflation include a measurable transfer of real wealth among households. Savers who invest in fixed-income instruments see their financial positions erode, while debtors with fixed-rate debt witness a dilution of the real value of their obligations.

For loans or mortgages with variable interest rates or short maturities, the sudden increase in short-term interest rates, driven by monetary policy, places a heavy burden. The current interest rates cycle with the largest increase in the shortest time - 450 basis points in little more than a year - has been demanding.

When it comes to addressing the accumulation of risks to financial stability, the primary lines of defense are microprudential and macroprudential policies.

National macroprudential policies may be designed to fine-tune the impact of transversal monetary policy. This can be achieved, for instance, through revised borrower-based measures.

Furthermore, in situations where risks are sector specific, for instance in real estate markets, capital-based instruments remain at the disposal of policymakers.

However, there is a delicate balance between the stance in macroprudential policies in the running up to the end of the financial cycle and the stance in which macroprudential authorities perceive that the risks are already materialising.

Macroprudential buffers are built to encourage banks to retain profits, in tandem with the actions of microprudential supervisors. However, when risks are starting to materialize a more aggressive easing of macroprudential policies might be warranted, recognising that microprudential supervisors tend to adhere to more stringent policies.

Numerous other key policy dilemmas confront policymakers, including new risks to financial stability arising from bigtechs, fintechs, cybersecurity, and climate change.

Today's financial landscape is evolving at an increasingly rapid pace, driven by continuous innovation, greater reliance on digital platforms, and the emergence of mixed-activity groups.

It would be short-sighted to believe that regulating and supervising these global risks and international players at the national level will suffice.

We need international cooperation and coordination to set up a robust framework and avoid the possibility of regulatory arbitrage. We will touch upon this issue later today.

While the prospect of cheaper and more accessible financial services is appealing, there is an undeniable risk that some new entrants might not be viable in the long run. Crypto-assets and Decentralised Finance, or DeFi, exemplify this risk. While proponents of crypto and DeFi talk about the democratisation of finance, it is not clear whether it will actually materialise, especially given the highly technical nature of this space.

Recent years have witnessed extreme volatility in crypto-asset and DeFi markets. These volatile products experienced an enormous surge in popularity during the Covid-19 pandemic, but proved to be unsustainable and, unsurprisingly, culminated in the collapse of several products.

It is still unclear whether these highly volatile products are here to stay. What is clear, however, is that the European Union has not been idle. In June this year, MiCA, the Markets in Crypto-Assets Regulation, entered into force. This uniform EU market rules represent the initial step toward regulating this market comprehensively.

But, as in bigtechs, we need further international coordination to address the still fragmented regulatory landscape. We will discuss if and how this might be achieved.

It still needs to be seen how these developments will affect the business model of traditional banks and their ability to provide credit.

Regulators will have to strike a careful balance between bringing new players within the regulatory perimeter and avoiding stifling innovation.

The principle of "same risk, same regulation" should guide these efforts. Whether effective supervision will be achieved through an entity-based approach, or an activity-based approach is still an open question.

In today's world, climate transition and physical risks are paramount in the new financial landscape. In this regard, let me highlight three of the most indisputable conclusions.

1. The first one is that climate-related financial risks are global in nature. They transcend geographical boundaries and economic sectors, impacting us all.

2. Secondly, climate-related financial risks may be a source of systemic risk.

3. And thirdly, as a corollary, addressing such risks and their sources necessitates global coordination and cooperation.

The scale and intensity of climate transformations and impacts and the transition to a low-carbon economy represent a paradigm shift for financial institutions, regulators, and supervisors.

Against this background, the European framework for prudential regulation and supervision applicable to banks is currently under discussion.

At the microprudential level, discussions evolve around the need for enhanced prudential requirements that reflect the intrinsic risk profile of exposures and support the soundness of individual financial institutions.

However, microprudential tools alone may not adequately address all dimensions of climate-related financial risks faced by the financial sector. Thus, macroprudential tools may be necessary and complementary to address environmental risks, as we are going to explore today.

The complexity and magnitude of the challenges at hand demand a holistic approach by regulators and supervisors across the financial sector. From a financial stability point of view, it is crucial to ensure that measures taken do not lead to the transfer or accumulation of climate-related risks outside the purview of banking supervision.

Allow me a quick word on the challenges faced by individual banks in the US and Swiss banking sectors earlier this year. While stemming from distinct causes, they underscore the importance of assessing the resilience of the broader banking system and the need for cooperation and coordination mechanisms.

The enhancement of the regulatory framework through the full implementation of the Basel III reforms will significantly contribute to the resilience and proper functioning of the banking system, which plays a pivotal role in sustaining economic growth.

To conclude, inspired by this wonderful setting, I wish you all a highly productive conference filled with engaging discussions and the exchange of valuable insights.

Thank you.

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