I should like to start by warmly welcoming all of you on this occasion. It is a great pleasure and honour to have you all here at this Conference. I should particularly like to extend a warm thank you to the speakers and the authors of the many interesting papers, which will be presented and discussed during these two days. I am sure that they will contribute to a very fruitful discussion between academics, central bankers and market participants, which will be of great help to us in our work towards refining and developing our operational framework. I should also like to extend a special welcome to our colleagues from the Federal Reserve Bank, the Bank of Japan and the Bank for International Settlements.
The topic of the Conference is the operational framework of the Eurosystem and the financial markets. In practice, the operational framework of the Eurosystem covers - or is closely connected with - issues relating to a vast range of areas, including foreign exchange operations, foreign reserve management as well as payment and securities settlement. Notwithstanding the importance of all these areas, we are focusing at this Conference on those topics, which are most closely related to the implementation of monetary policy.
The purpose of the Conference is to assess how well the operational framework of the Eurosystem has worked in practice and to discuss possibilities for improvement. The environment in which our operational framework is set, that is the euro area financial markets, has already undergone changes since the introduction of the euro. The operational framework of the central banks must live alongside these developments. We are open to any suggestions for possible improvements.
In my presentation today, I should first like to recall some aspects of the history of the operational framework, especially how it was designed. I should then like to say a few words about our experience of the framework thus far, and in particular outline the areas in which we see a need for further changes and improvement in the short and in the medium term. I will conclude my presentation by underlining some longer-term issues.
Work to set up the operational framework of the Eurosystem was begun in 1994, within committees composed of representatives from all EU central banks under the aegis of the European Monetary Institute, the forerunner of the European Central Bank. I am not exaggerating when I say that all of us who were involved in the project initially underestimated the magnitude of the task before us and the efforts, which would be required. The complexity of the task of bringing together the systems, procedures and practices of the EU central banks to form a consistent and harmonised framework turned out to be very challenging.
The process of analytical discussion, debate and compromise is typical of mergers of different "corporate cultures". I believe that we managed to make this process work constructively at a very early stage. We carefully studied the frameworks, but also the transmission mechanisms of monetary policy for each country of the European Union, as well as those of several non-EU countries.
The Treaty on European Union ("Maastricht" Treaty) already gave some guidance on the requirements of the operational framework: it had to contribute to the overall task of maintaining price stability; it had to be market-oriented and favour an efficient allocation of resources; and, in addition, credit operations had to be fully collateralised in order to ensure the safety of the Eurosystem.
In a spirit of mutual understanding, a set of additional guiding principles was defined for establishing the operational framework. Among the most important of these principles were the need to ensure operational efficiency, the need to ensure equal treatment of financial institutions, decentralisation of the implementation of monetary policy, harmonisation of rules and procedures, and finally the principles of simplicity and transparency. In addition, it was agreed that, in order to smooth the changeover to the new regime, continuity with the current practices of the national central banks should be respected to the extent that this did not conflict with the other principles.
I have mentioned these principles, which we will also discuss later during the Conference, because they continue to be equally important today. In the future development of the implementation of our monetary policy, the weighting of these different principles may of course gradually change. For instance, the principle of continuity of the original national systems is naturally becoming less important as the euro area financial markets become ever more integrated.
On the basis of these principles, the current operational framework was established. Today we are very satisfied with the outcome. Naturally, we sometimes had to resort to compromises. One such compromise was reached on the issue of whether reserve requirements should be imposed or not. Some members found reserve requirements with an averaging mechanism to be an essential part of the framework in order to enlarge the structural liquidity deficit of the banking sector and stabilise the overnight market interest rate without the need for frequent recourse to open market operations. By contrast, others considered them to be in conflict with the principle of market-orientation. Here, a compromise solution of using fully remunerated reserves was found, which - with hindsight - was a wise decision.
The technical changeover to the systems required for the implementation of the single monetary policy was in itself a remarkable achievement. The monumental task of more or less simultaneously implementing changes in thousands of computer programs and in operational procedures throughout the central banks and the financial markets was carried out with only few problems. The successful technical launch of the euro was made possible thanks to the strong commitment on the part of - and careful preparations by - all those involved in the project.
Let me now turn to the experience gained since the introduction of the euro. Before the start of Economic and Monetary Union, we sometimes heard criticism to the effect that our decentralised monetary policy framework was bound to become too complex and inefficient. However, from a technical point of view, highly developed information technologies make decentralisation entirely feasible. After 16 months of experience with this system, we no longer hear such criticism. There seems to be almost unanimous agreement that it works well and that making use of the national central banks' considerable experience in dealing with their national counterparties is a benefit to the whole system.
Therefore, one may say that concerning our organisational set-up we reached a kind of equilibrium: On the one side, we can profit from the human capital and the long experience of national central banks as well as of their direct and numerous contacts with market actors. On the other side, it cannot be denied that a decentralised implementation of monetary policy is in some respects more complicated. In central banking, as in other economic activities, economies of scale are important for efficiency. This may become increasingly true in the case of the Eurosystem when new Member States join the European Union and adopt the euro. Therefore, in the longer-term, some aspects of the operational framework might become more concentrated, also in line with what we experience concerning the developments of financial markets towards greater integration and concentration.
The current operational framework of the Eurosystem is market-oriented and comprises many different instruments, a wide range of counterparties and a wide collateral base. This implies a degree of flexibility, which proved particularly useful, for instance in the context of the century date change. We did not need to devise any special instruments or facilities to meet the challenges of the year 2000.
As the experience gained so far has shown, the euro area liquidity situation in general has been effectively managed and monetary policy signals have been transmitted in a clear way to the market - thanks to the chosen operational framework. I should also like to highlight the fact that the framework has been conducive to promoting the smooth integration of the money market. Indeed, credit institutions have swiftly adapted to the new regime of a euro area-wide market.
Clearly, the positive experience gained by the Eurosystem with the implementation of monetary policy is the result of a form of partnership between the Eurosystem and its counterparties. We all share the goal of ensuring that the money market works smoothly, that transactions are settled without problems throughout the euro area and that monetary policy signals are transmitted efficiently.
Despite the generally positive experience gained with the implementation of monetary policy, we see that there is scope for improvement. It would have been an illusion to believe that we could create a perfect system immediately. In fact, I do not believe that there could ever be a system, which is perfect in all respects.
I should like at this juncture to highlight only a few areas in which we have identified problems so far. I expect that the discussions at this Conference will bring to light other areas where improvements are also possible.
One significant problem relates to the extensive bidding in our main refinancing operations. These operations are currently conducted in the form of fixed rate tenders, where in addition to the price, the amount of liquidity is decided by the ECB - on the basis of our forecasts of the liquidity needs of the whole area. Currently the amount of bids in each operation exceeds the amount allotted by 50 - 100 times. In times of rate hike expectations in the market, it is generally perceived by counterparties as beneficial to try to fulfil minimum reserves as early as possible in the maintenance period. In this kind of situation, there is an incentive for counterparties to bid as much as possible and there is no equilibrium for the allotment ratio.
Overbidding is not a new phenomenon as such. To a certain extent, it has been experienced by most central banks using similar systems. However, it is naturally more complex to deal with this problem in a euro area-wide context than at a national level. For example, prior to the introduction of the euro, several national central banks were able to limit the problem of overbidding by requiring counterparties to have a sufficient amount of collateral available to cover their full bids, thereby making it costly to submit excessive bids. For various reasons, such a solution simply does not work in a euro area-wide context. The availability of collateral and the cost of holding collateral differ considerably across Member States and such a requirement would, in practice, not be a binding constraint for counterparties in some countries, while it would be a very costly restriction for counterparties in other countries. It would therefore violate the principle of equal treatment. In some countries, there is virtually no technical possibility for checking compliance with such a rule, and in still other countries it would not be legally sound to impose any sanctions in the event that a breach of the rule were to be detected.
Apart from the fact that I personally find it disturbing from an optical point of view to have allotment ratios creeping down towards 1%, the main problem is that the lower the allotment ratio, the higher the upward risk to the allotment ratio and the higher the uncertainty in the allotted amount become. Therefore, counterparties experience a high degree of uncertainty with regard to the amount of collateral required to settle the resulting transaction at the time the bid is submitted. This uncertainty is costly for counterparties, and it is particularly costly for counterparties in the countries where availability of collateral is restricted or where the marginal cost for collateral is high.
Of course, if we adopted the more market-oriented variable rate tender procedure, the problem would not exist. However, the well-known advantage of the fixed rate tender procedure is the clear signalling of the monetary policy stance.
Clearly, the Eurosystem is aware of the overbidding problem, which we have been actively discussing among ourselves, and we expect many useful comments and analyses on this point from all of you. We will have to address this issue, in one way or another, in the near future.
Another aspect of the operational framework, which requires further work, relates to our collateral policy. Although the wide collateral base is advantageous for the counterparties, the present two-tier system - where tier one is the same throughout the euro area, while the second tier is defined by each national central bank - is certainly not optimal. The two-tier collateral system was originally defined with a view to responding to the principle of continuity of earlier practices in different Member States. In a situation of large initial differences across the Member States with regard to the availability of collateral, the development of securities markets, the legal environment and the practices implemented by the national central banks, an immediate and complete harmonisation would have led to major difficulties for banking systems in many parts of the euro area.
Yet, the heterogeneous collateral framework necessarily implies problems of equal treatment and, in particular, it results in complex procedures - not least in a cross-border context - which contradict the principles of operational efficiency, simplicity and transparency. We are well aware of these problems too, and we will address them step by step, over the medium term.
The two problems, which I have highlighted, are examples of the fact - entirely natural - that the operational framework is not and never will become "final". There will always be a need for improvement as well as for adaptation to changes in the environment. As I have already said, in pursuing this work it is our serious intention to maintain close contacts and an ongoing dialogue with market participants as well as with academics and other interested parties.
Looking further ahead, what changes in the environment will affect this development process in the longer run? In fact, it is easier to say what will not change: the basic goal and function of the operational framework will not change. This is the implementation of a single monetary policy with the primary objective of maintaining price stability. The market-oriented approach and the requirement of adequate collateralisation are other aspects, which will not change.
But the operational framework of the Eurosystem will need to be adjusted to market developments. In particular, it will need to accompany the integration of the European financial markets and their infrastructure, in order to support the development of more homogeneous and efficient channels for the transmission of monetary policy.
Indeed, the development of our system will need to take account of new challenges posed by the rapidly progressing integration of financial markets as well as of the banking sector, and clearly we do not want the operational framework to hinder these developments. Pressures to further improve the possibilities of transferring money and securities throughout the euro area - and globally - will have an impact on the operational framework. Improved technology and a market-oriented consolidation of infrastructure systems, aiming in particular at increasing efficiency and reducing costs with due consideration to safety considerations, will provide new means in this respect. The development of electronic money is only one example of the changes, which may affect the implementation of monetary policy.
Innovation and developments in financial markets, such as, for instance, those generated by the widespread use of information technologies and electronic trading, could affect the implementation of monetary policy too, both through their impact on the transmission channel of monetary policy, as well as through their legal and technical consequences.
One particular challenge, which we will face in the future, is the geographical widening of the euro area and the integration of new Member States and their financial markets into the European Union and into the euro area systems. This will require legal and technical adaptation, not necessarily only in the new Member States, but sometimes possibly also in the euro area.
I know that many of the issues I have touched upon here - together with many other - will be thoroughly scrutinised during these two days. I am convinced that the discussion will provide a very fruitful contribution to the future development of our operational framework. I am very much looking forward to this.
Once more, I warmly welcome all of you to the ECB and to this Conference.
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