Financial Stability Concerns Won’t Stop ECB Inflation Fight, Schnabel Says

19 May 2023

By Xavier D’Arcy – FRANKFURT (Econostream) – Financial stability concerns do not pose an obstacle to the European Central Bank’s hiking cycle, ECB Executive Board member Isabel Schnabel said on Friday.

In a speech in London, Schnabel said that ‘the resilience of euro area banks’ meant there was ‘no trade-off between price stability and financial stability’ and the ECB could ‘continue to do whatever is needed to bring inflation back to our 2% target in a timely manner.’

This implied ‘raising rates to a sufficiently restrictive level and keeping them at that level for as long as necessary', she said.

However, there was ‘no room for complacency as financial stability risks may be hidden below the surface of relatively calm financial markets and benign regulatory ratios’, she said.

Whilst rising interest rates meant increased profitability for most banks, there had been a shift from overnight deposits into higher-yielding alternatives in the Eurozone, which implied that net interest margins were ‘bound to shrink over time, as funding costs eventually rise more strongly than banks’ interest income in many cases’, she said.

ECB models showed that ‘due to a duration mismatch, the economic value of equity of most euro area banks drops over the long run in response to rising interest rates’, she said.

These potential impacts of rising interest rates meant that Eurozone banks’ strategies for dealing with higher rates and duration mismatch needed ‘to be monitored carefully’, she said.

‘Both banks and non-banks may be facing additional headwinds in future. Higher interest rates will eventually cool the economy, possibly leading to higher credit risks’, she said.