NEW YORK -(Dow Jones)- Lorenzo Bini Smaghi, a member of the European Central Bank's executive board, stressed Monday that the ECB's new program to purchase euro-zone sovereign bonds is aimed at improving its capacity to influence credit markets and not at financing public debt.
"[W]hile central banks will be called upon to support market functioning in liquidity crises when the integrity of the transmission mechanism is threatened, they cannot be asked to rescue insolvent issuers--whether private or public institutions," Bini Smaghi said, according to the prepared text of remarks released before he spoke at Barclays Capital's annual Global Inflation-Linked Conference in New York.
"In line with this principle, the SMP [Securities Market Program] is meant to repair the integrity of the transmission mechanism, not to finance public debt," he added. The Barclays event was closed to the press.
The SMP was announced on May 10 amid a growing sovereign debt crisis in the euro zone that has caused stress in short-term money markets across the single currency area. It was announced in conjunction with a new EUR720 billion bailout facility for struggling sovereign issuers to be managed by the European Union and the International Monetary Fund.
There was initially some resistance to the measure within the ECB, mostly because officials feared it would be perceived as a form of quantitative monetary easing and represent a departure from the ECB's firm commitment to price stability. There were also concerns that the actions could effectively underwrite governments' borrowing activities and so discourage moves to control fiscal spending.
In his remarks, Bini Smaghi addressed both concerns. He concluded it by stating that "in a changing financial environment, the only way to maintain credibility is to safeguard the ultimate objective, which is price stability."
Most of Bini Smaghi's speech was dedicated to the growth of securitization in credit markets and to the related rise of the so-called shadow-banking system, which evolved before the 2008 financial crisis to largely supplant deposit-gathering commercial banks as the key source of credit creation. He also spoke of the role that collateral-based lending plays in that system and what it means for central banks' ability to impact the broader economy with their policies.
On that, he was mostly sanguine about central banks' capacity to retain control, arguing that their short-term interest targets will continue to have a powerful and direct impact on liquidity conditions in money markets that depend on collateralized lending.
However, to ensure that their liquidity-providing activities don't encourage moral hazard and threaten the health of the financial system within which central banks operate, other financial regulation needs to broaden so that the shadow banking system is brought under the umbrella of bank supervision and regulation, he said.
"If we want central bank control over leverage to be stronger in the future, shadow banks need to be part of what we consider banks," Bini Smaghi said.
Copyright 2009 Dow Jones Newswires
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