ECB’s Knot: Adjustment to a World of Higher Interest Rates ‘Challenging’

11 November 2022

By David Barwick – FRANKFURT (Econostream) – European Central Bank Governing Council member Klaas Knot on Friday warned that the tightening of monetary policy globally posed risks to the stability of the financial system.

In a letter he wrote as chair of the Financial Stability Board to G20 leaders ahead of their November summit in Bali, Knot, who heads De Nederlandsche Bank, said that developments since G20 leaders met in Rome at the end of October 2021 ‘have been a stark reminder that global financial stability should not be taken for granted.’

‘The return of inflation to levels not seen in decades has resulted in a strong interest rate response and significantly tighter financial conditions’, he continued. ‘The growth outlook has weakened, a development which is exacerbated by heightened geopolitical tensions and pronounced uncertainty.’

With debt of non-financial companies, households and sovereigns at record highs, financial system vulnerabilities could be exposed, he wrote.

For now, however, the global financial system has proved resilient, he said, but he warned against complacency.

‘The record-high debt levels have made markets sensitive to the impact of policy actions on debt servicing costs and debt sustainability’, he said. ‘Moreover, financial institutions and market participants have not experienced sharply rising interest rates for a long time … making the adjustment to a world of higher rates challenging.’

‘More fundamentally, the current tightening is occurring in a global financial system where the provision of finance through non-banks has become as important as bank credit’, parts of which segment ‘are not very transparent and are subject to vulnerabilities which can be triggered during periods of market stress’, he said.