The year at a glance

While the economic expansion in the euro area continued in 2018, the economy experienced a loss of growth momentum. Growth decelerated from 2.5% in 2017 to 1.8% in 2018 as a series of headwinds emerged over the course of the year. A significant weakening of world trade, coupled with a number of country and sector-specific factors, weighed on the external sector and manufacturing in particular.

The domestic economy nonetheless remained relatively resilient, buoyed by a continuing recovery in the labour market. Employment has increased by 10 million people since the trough in mid-2013 and the unemployment rate fell to 7.8% in December, the lowest rate since October 2008. Strong labour market dynamics translated into steady and broad-based wage growth, which reached 2.2% in the last quarter. Rising employment and wages in turn helped underpin consumer spending.

Headline inflation increased relative to the previous year, averaging 1.7% over 2018, although this mostly reflected higher energy prices. Measures of underlying inflation moved broadly sideways throughout the year. However, the outlook for domestic demand, the labour market and wage growth gave us confidence that inflation would continue to converge towards our objective over the medium term.

As a result, the Governing Council anticipated in June 2018 reducing the monthly pace of net purchases under the asset purchase programme (APP) to €15 billion from September and – subject to incoming data confirming its medium-term inflation outlook – ending net purchases in December. At the same time, the Governing Council communicated that it expected the key ECB interest rates to remain at their present levels at least through the summer of 2019^[1] and in any case for as long as necessary to ensure that the evolution of inflation remained aligned with expectations of a sustained adjustment path.

In December, the Governing Council reviewed the economic outlook and concluded that the June assessment remained broadly accurate. On that basis, it ended net asset purchases under the APP and confirmed the enhanced forward guidance on the path of interest rates. In parallel, it confirmed the need for continued significant monetary policy stimulus to support the further build-up of domestic price pressures and headline inflation developments over the medium term.

That stimulus would be provided by forward guidance on key interest rates, reinforced by reinvestments of the maturing principal payments of the sizeable stock of assets acquired under the APP. The Governing Council conveyed that such reinvestments would continue for an extended period of time past the date when key interest rates rise, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

The Governing Council also confirmed that, in any event, it stood ready to adjust all of its instruments, as appropriate, to ensure that inflation continued to move towards our aim in a sustained manner.

The continued domestic recovery and micro- and macroprudential actions also helped support financial sector resilience in 2018. The aggregate Common Equity Tier 1 ratio of significant institutions reached 14.2% at the end of the third quarter of 2018. Outstanding non-performing loans (NPLs) declined by €94 billion in the first three quarters of 2018, and euro area significant institutions’ aggregate NPL ratio stood at 4.2%, down from 5.2% a year earlier.

Risk-taking in parts of the financial and real estate markets contributed to mild signs of overstretched valuations in some areas, with marked cross-country differences, while risks continued to grow in the non-bank financial sector. In this environment, macroprudential measures were implemented in euro area countries to mitigate systemic risks: during 2018 the ECB assessed 103 notifications of macroprudential policy decisions by national authorities.

The ECB continued to support the benchmark reform in the euro area, developing a new money market reference rate during 2018. The ECB published the methodology for the euro short-term rate (€STR) in June 2018 after it received broad support in two public consultations. The €STR is based on average daily volumes of approximately €32 billion as traded by around 32 banks. The private sector working group on euro risk-free rates recommended the €STR as the replacement for EONIA in September 2018. The €STR will be available in October 2019, following a period of thorough internal testing by the Eurosystem.

2018 also marked a significant step forward in euro payments. In November, the Eurosystem launched the TARGET Instant Payment Settlement (TIPS) service, which offers instant payments around the clock in less than ten seconds.

As shown by the December Eurobarometer, support for the euro in 2018 rose to 75%. The ECB continued its efforts to connect with euro area citizens and to improve its accountability and transparency by engaging with the European Parliament, but also by expanding our “Youth Dialogues” and by fostering the use of our website, social media and Visitor Centre.

Turning to the coming year, substantial monetary policy stimulus remains essential to ensure the continued build-up of domestic price pressures over the medium term. In view of the persistence of uncertainties related to geopolitical factors, the threat of protectionism and vulnerabilities in emerging markets, the conduct of monetary policy in the euro area will continue to require patience, prudence and persistence.

Frankfurt am Main, April 2019

Mario Draghi
President

The year in figures

1 Economic activity continued to expand at rates above potential, while cost pressures strengthened and broadened

Following the exceptionally strong growth dynamics in 2017, the euro area economic expansion continued in 2018, albeit at a more moderate pace as external demand weakened and some country and sector-specific factors dampened growth. At the same time, the underlying drivers of domestic demand remained in place. Further improvements in the labour markets supported private consumption, while business investment continued to benefit from favourable financing conditions and improving balance sheets. The ongoing expansion and tightening of labour markets also translated into a continued strengthening and broadening of domestic cost pressures. At the same time, measures of underlying inflation remained generally muted. However, looking ahead, underlying inflation is expected to increase over the medium term, supported by the ECB’s monetary policy measures, the ongoing economic expansion and rising wage growth.

1.1 A less balanced global expansion

The global economic expansion continued at a steady pace of 3.6% in the first three quarters of 2018, a rate similar to that in the preceding year and close to its long-run average (see Chart 1). However, compared with previous years, the upturn in economic activity became more uneven and less synchronised across countries. While growth remained robust in the United States, it faltered in a number of other economies, including Japan and some emerging markets, in particular Turkey and Argentina. Activity also decelerated in China in the second half of the year. Looking at the different components, growth in industrial production and world trade weakened, while private consumption growth remained solid.

As the ninth consecutive year of the current global expansion began, unemployment rates across both advanced economies and emerging market economies continued to decline and, in many countries, stood at post-crisis lows. In some cases, they even stood at historical lows, such as in the United Kingdom and in Japan. Labour shortages became evident in several advanced economies, especially among specialised and highly skilled workers.

There are increasing signs that the ongoing decline in slack in both productive capacity and labour markets at the global level has been gradually, albeit only slowly, translating into higher wage growth and higher underlying inflation. In the OECD area, underlying inflation (excluding energy and food) increased to 2.1% in 2018. Headline inflation increased much more strongly, reaching 2.6% in annual terms, although it subsided in the second half of the year mostly on account of lower oil prices (see Chart 2).

Supply-side developments were a key factor driving oil prices in 2018, in an environment of continued solid global demand and tight inventories. In the first half of the year oil prices rose gradually from around USD 67 per barrel to USD 79 per barrel, following a greater than expected compliance by the 22 OPEC and non-OPEC producers with their agreed production cuts. Oil prices fluctuated between USD 70 and USD 86 per barrel until early autumn, but declined thereafter to around USD 52 per barrel by year-end. The rise to a high of USD 86 per barrel by early October was related to fears of a steep decline in Iranian oil exports, following the reintroduction of sanctions by the United States. However, oil prices significantly moderated by the end of December owing to a combination of weakened demand prospects and concerns over excess supply as the United States, some OPEC members and the Russian Federation increased their production. In addition, there were some exemptions from the sanctions imposed on the Islamic Republic of Iran. Meanwhile, non-oil commodity prices decreased overall in 2018 (in US dollar terms).^[2] Food and metal prices remained broadly stable in the first half of 2018. Food prices declined during the second half of the year amid both ample global food supply and concerns about US tariffs and the risk of retaliation by affected countries. Metal prices also retreated since the summer due to lower demand from China, as well as concerns about an escalation of trade tensions.

The exchange rate of the euro appreciated in nominal effective terms (see Chart 3) since the beginning of 2018. In bilateral terms, the euro depreciated vis-à-vis other major currencies. The depreciation of the euro was particularly pronounced against the US dollar, the Japanese yen and – albeit to a lesser extent – the Swiss franc. At the same time, the euro appreciated significantly against most emerging market currencies, in particular the Chinese renminbi and, as a result of domestic headwinds, the Turkish lira and the Argentinian peso.

While global growth continued at a solid pace, risks and uncertainties increasingly clouded the outlook. In particular, trade uncertainty rose following actions by the US administration and responses by its trading partners. This culminated with two announcements by the US administration of tariffs targeting USD 250 billion of Chinese exports in the summer, and China announced retaliation on USD 110 billion of exports from the United States. In addition, doubts over Brexit also weighed on the trade outlook. While the direct impact of these tariffs should remain contained at the global level, such protectionist threats have the potential to erode confidence, disrupt global value chains and adversely affect investment, and in turn constitute a downside risk to the global economic outlook. By the end of the year there were already signs that trade uncertainty had started to affect the conduct of business. If trade disputes escalate further, global growth could be severely impaired.

1.2 Economic growth moderated, but remained consistent with an ongoing expansion

Following the exceptionally strong growth dynamics in 2017, euro area real GDP growth moderated to 1.8% in 2018 (see Chart 4). Although this slowdown was mainly attributable to a weakening in global trade, other factors of a more transitory nature also played a role. In the first half of 2018 weather-related disruptions and industrial action, especially in the transportation sector, affected output in a number of countries. In the second half of the year, and in particular in the third quarter, there was a significant disruption of automobile production following the introduction of the Worldwide Harmonised Light Vehicle Test Procedure on 1 September. Furthermore, the decline in growth may have been compounded by an increase in political uncertainty, particularly in relation to the prospect of increasing protectionism.

At the same time, the underlying growth momentum remained solid, supported by a robust labour market and steady income and profit growth. Spillovers from the weakness of and heightened uncertainty about external demand to domestic demand have so far remained contained.

Euro area private consumption increased in 2018 at an average annual growth rate of around 1.3%, supported by stronger labour income and favourable financing conditions. At the same time, the gradual increase in oil prices since mid-2017 did not significantly dent the growth of real disposable income. As the economic expansion progressed, the contribution of taxes and transfers became somewhat more negative in 2018. In good times, automatic fiscal stabilisers tend to have a dampening effect on the growth of real disposable income.

Domestic demand growth, favourable financing conditions and corporate profitability continued to support euro area business investment in 2018. Investment increased also in sectors facing capacity constraints such as the transportation sector. However, the less dynamic external environment and the heightened global uncertainty, in particular in relation to trade policies, weighed on the investment activities of firms, particularly those more exposed to the external environment. Going forward, business investment growth is likely to moderate in view of the less supportive external environment and more moderate final demand, and the expected gradual tightening of financing conditions.

Construction investment, both residential and non-residential, also continued improving, albeit from low levels, alongside the recovery in euro area housing markets. This, in turn, reflected growing domestic demand, which was supported by real income growth, a low interest rate environment and favourable lending conditions. Nevertheless, bottlenecks in the labour market appear to have limited growth in the construction sector in the course of 2018.

In 2018 the contribution of the external sector to the overall euro area performance was particularly modest, at any rate significantly weaker than in 2017. Waning foreign demand, especially from Asia and in particular for capital goods, due to increased uncertainty and heightened trade tensions undermined euro area exports to the region and acted as a drag on the total net trade contribution to GDP. Exports to the United Kingdom and China suffered the most from the changing international environment, while exports to the United States benefited, probably from anticipation effects in relation to the risk of the US administration also enforcing tariffs on imports from the EU. Supported by positive economic developments in the area, the trade momentum within the euro area initially proved resilient. However, it weakened significantly in the second half of 2018 as trade uncertainty and new car emission standards took a toll on trade in capital goods and cars. Some headwinds may also have arisen from past euro exchange rate appreciations.

Output growth in 2018 continued to be broad-based across economic sectors (see Chart 5). Total gross value added rose further, by around 2%, which was somewhat lower than in the previous year, but close to the growth rates recorded in 2015 and 2016. Value added in industry (excluding construction) and value added in the services sector both increased by around 2% in 2018. At the same time, value added in construction, albeit still below its pre-crisis level, continued its expansion, rising by around 4%. This again confirmed that the construction sector is increasingly recovering from the protracted period of contraction or slow growth that followed the onset of the financial crisis in 2008.

Euro area labour markets continued to improve, while the age composition of employment changed

Euro area labour markets recovered further in 2018 (see Chart 6). The unemployment rate continued to decline in 2018 and stood at 7.8% in December, the lowest rate since October 2008. The decline in unemployment, which started in the second half of 2013, has been broad-based across gender and age groups, while levels of the unemployment rate continue to differ significantly across euro area countries. By the fourth quarter of the year the number of persons employed in the euro area stood 1.3% above the level at the same time in 2017, or 6.7% above the last trough in the second quarter of 2013. Over the whole recovery period, employment has increased by around 10 million persons. This has taken the level of employment above its pre-crisis peak reached in the first quarter of 2008. Employment growth over the recovery has been broad-based across countries and sectors, and has occurred against the background of further increases in labour supply.

A closer look at the composition of employment growth over the recovery reveals that the growth has been concentrated among older persons.^[3] Indeed, about three-quarters of the cumulative employment growth has come from those aged between 55 and 74. The increasing employment of the older population during the recovery is primarily due to the rising participation rate of this group. This can be assumed to largely reflect the impact of past pension reforms, as well as increasing education levels in this group. The significant increase in the share of older workers in employment may give rise to far-reaching changes in the economy, through impacts on patterns in consumption, savings and investment, as well as on wage and productivity developments.^[4] Over the recovery, about one-third of employment growth has come from part-time employment, which is closely linked to the longer-term upward trends of increasing labour supply by female and older workers, as well as of continuing concentration of employment growth in the services sector.^[5] Looking ahead, labour shortages in some countries and sectors can be expected to contribute to a moderation in these continuing trends.

Government deficit continues to fall, but uneven risks remain

The euro area general government deficit ratio continued to decline in 2018 and reached 0.6% of GDP, a level rarely seen since the start of Economic and Monetary Union (EMU) in 1999 (see Chart 7). As has been the case over the last few years, the fall in the overall deficit was to a large extent the result of favourable cyclical developments, in combination with falling interest expenditures as maturing high-cost debt continued to be replaced with new debt issued at lower interest rates. The euro area fiscal stance^[6] was broadly neutral in 2018, although the euro area aggregate masked significant differences across countries, with large windfalls in a few countries compensating in the aggregate for procyclical fiscal loosening in vulnerable countries.

In a context of expanding economic activity, the falling government deficit contributed to sustaining a decline in the ratio of gross debt to GDP, from 86.6% in 2017 to 84.8% in 2018. While the debt ratio is projected to decline also over the coming years, it should be kept in mind that it remains significantly higher than at the start of EMU. High debt levels constitute a vulnerability, and particularly so in countries that suffer from low potential output growth and face growing demographic challenges (see Box 1). Such countries would have limited margins to adjust fiscal policies in the event of a deterioration in economic activity or increasing interest expenditures. Vulnerable countries would therefore be well-advised to build up buffers now that economic conditions allow it.

In this light, it is of concern that compliance with the Stability and Growth Pact (SGP) is weakest for those countries that are most vulnerable to shocks. In fact, according to the European Commission projections, most of the countries that have not yet reached sound budgetary positions missed their commitments under the SGP in 2018. Among the seven euro area countries that are assessed by the Commission to be at risk of a deviation from the SGP’s preventive arm in 2018, four countries – Belgium, France, Italy and Portugal – have debt ratios above 90% of GDP. In addition, while Spain – the only country subject to an excessive deficit procedure (EDP) in 2018 – is projected to meet its 2018 EDP correction deadline, this achievement masks a high and increasing structural deficit, as opposed to the recommended improvement. Furthermore, the European Commission’s assessment indicates that only ten countries intend to be compliant with the SGP according to draft budgetary plans for 2019. It is particularly worrying that most of the countries with high debt ratios are not included in this group.

Reform momentum in the euro area remains lacklustre

The country-specific recommendations (CSRs) provide policy recommendations tailored to an individual country on how to enhance economic growth and resilience, while maintaining sound public finances. The CSRs are jointly endorsed by Member States in the European Council. Similarly to last year, the Commission concluded that the overwhelming majority – more than 90% – of reform recommendations given to euro area countries in 2017 have been followed by only “some” or “limited” progress in implementation, while none has been fully implemented (see Chart 8).^[9]

Well-designed structural reforms could yield substantial benefits for euro area citizens via stronger and more inclusive growth in employment and incomes. A recent Eurosystem analysis shows that there are ample opportunities for reforms that simultaneously enhance resilience, long-term growth and social fairness.^[10] A case in point are reforms that address rent-seeking, in particular those strengthening product market competition and the quality of public institutions. Similarly, policies supporting education and life-long learning improve not only an economy’s long-term growth prospects, but also the employment opportunities of vulnerable groups of society.

1.3 Inflation on a higher path

Headline inflation in the euro area, as measured by the Harmonised Index of Consumer Prices (HICP), rose to 1.7% on average in 2018, from 1.5% the year before. This increase largely reflected higher contributions from energy prices and, to a lesser extent, food prices. By contrast, the contribution of underlying inflation, as measured by HICP inflation excluding energy and food, remained broadly unchanged. This inflation measure remained subdued, moving essentially sideways around 1% throughout the year (see Chart 9).

Developments in energy prices strongly influenced the intra-year profile of headline HICP inflation. Driven by the rise in crude oil prices, energy inflation increased strongly between April and July and thereafter remained at high year-on-year rates of change (with a peak of nearly 11% in October 2018). Thus, the contribution of energy inflation to headline inflation rose from 0.2 percentage point in the first quarter of 2018 to 0.9 and 0.8 percentage point in the last two quarters of 2018. Developments in unprocessed food prices added to this intra-year profile due to the weather-related sharp increases in the annual rates of change of fruit and vegetable prices in the summer months, which however unwound in the last months of the year. This caused the contribution of unprocessed food to headline inflation to rise from zero in the first quarter of 2018 to more than 0.2 percentage point in September 2018, before declining somewhat in the last quarter of 2018.

HICP inflation excluding energy and food remained unchanged compared with 2017, moving like other measures of underlying inflation broadly sideways throughout the year.^[11] However, when also excluding the more volatile components related to clothing and travel, this underlying measure of inflation increased.

The rather subdued developments in HICP inflation excluding energy and food were observed in both main components, namely non-energy industrial goods and services. Non-energy industrial goods inflation showed some volatility, declining up to September 2018 before increasing somewhat thereafter, and stood at 0.4% in 2018, as in 2017. Looking at indicators for price pressures at different stages of the pricing chain, both the annual rate of change of producer prices for domestic sales of non-food consumer goods and that of import prices for non-food consumer goods increased in the course of 2018. In the case of import prices this essentially reflected the waning impact of the euro appreciation in 2017, while in the case of producer prices it likely reflected the growth in input costs and retail sales volumes. Services price inflation was broadly unchanged in 2018 at 1.3% and remained well below its long-term average. A modest pick-up occurred in the annual rate of change of services prices in the last quarter of 2018, but it largely reflected the base effect of rather weak developments in services inflation during the same months of 2017. Overall, inflation in services prices, which have a large labour cost content, has not yet mirrored the pick-up in wage growth.

Domestic cost pressures as measured by the growth in the GDP deflator remained constant in the first three quarters of 2018, slightly above the rate reached in the second half of 2017 (see Chart 10). The annual growth in compensation per employee, which had reached a trough in mid-2016, continued to increase in 2018, standing at 2.5% in the third quarter of the year, which was above its historical average of 2.1% (since 1999). Overall, the pick-up in wage growth reflected improved labour market conditions (see Section 1.2 above) and the fading-away of the factors that had contributed to containing wage growth in the past, such as the impact of low past inflation as a result of formal and informal indexation schemes and the effects of labour market reforms implemented in some countries during the financial crisis. In a moderately favourable demand environment, the higher wage growth translated into higher unit labour cost growth, but the impact of this on domestic cost pressures was mitigated by profit developments (measured in terms of the gross operating surplus), which have weakened in recent quarters, partly reflecting the negative impact of the terms-of-trade deterioration related to higher oil prices.^[12]

Longer-term inflation expectations were somewhat higher in 2018 than in 2017. Expectations for inflation five years ahead from the ECB Survey of Professional Forecasters have remained unchanged at 1.9% for a succession of quarters, staying slightly higher than in 2017. Market-based measures of longer-term inflation expectations, such as the five-year inflation-linked swap rate five years ahead, showed some volatility, declining towards the end of the year, but remaining broadly unchanged on average compared with 2017.

1.4 Favourable financing conditions supported credit and money growth

In 2018 euro area financial markets were influenced by uncertainties regarding the global and domestic euro area economic outlook in combination with politically induced risk-off sentiment – in particular relating to Brexit, trade protectionism and uncertainty about the policy stance of the Italian government on public finances. Money market rates and longer-term bond yields remained at very low levels, in part thanks to the continued monetary policy accommodation provided by the ECB. Financing conditions supported business investment, while household wealth underpinned private consumption. Money growth declined, while growth in credit to the private sector increased further.

Euro area government bond yields remained broadly unchanged in 2018, albeit rising slightly towards the end of the year (see Chart 11). This largely reflected spillovers from the gradual withdrawal of monetary policy accommodation in the United States, as well as the widening in Italian spreads, which has so far had limited spillovers to other euro area sovereign bond markets. The euro area GDP-weighted average of ten-year sovereign bond yields stood at 1.01% on 31 December 2018, broadly unchanged from the average level in 2017. The spread of euro area countries’ ten-year sovereign bond yields against the German ten-year Bund yield increased moderately, against the background of prevailing fiscal policy uncertainty.

Euro area equity prices decreased significantly in 2018, amid increased global tensions, Italian political uncertainty and the gradual normalisation of monetary policy accommodation in advanced economies (see Chart 12). More specifically, a broad index for equity prices of euro area non-financial corporations (NFCs) declined by 12.6% over the course of 2018, while an index of euro area bank equity prices decreased by 33.3%. Equity prices of NFCs in the United States were more resilient than those in the euro area owing to the strong macroeconomic momentum, which was in part related to the procyclical fiscal stimulus.

Overall, favourable financing conditions for NFCs continued to support business investment in 2018, although NFCs’ external financing flows decreased somewhat (see Chart 13). This decrease mainly reflected a moderation in “other” sources of financing (including inter-company loans and trade credit). At the same time, the net issuance of listed shares, unlisted shares and other equity was dampened by special factors and the relatively high cost of equity financing. Notwithstanding a gradual increase in corporate bond spreads over the course of 2018, debt securities issuance continued to be supported by the corporate sector purchase programme (CSPP), which was introduced in June 2016 (see Box 3). Moreover, the annual growth rate of bank loans to NFCs increased further in 2018. The recovery in loan growth has been supported by the significant decline in bank lending rates across the euro area since mid-2014 (see Section 2.1), which continued in 2018. This was in no small part due to the ECB’s non-standard monetary policy measures, which have brought about overall improvements in the supply of and demand for bank loans. In addition, banks have made progress in consolidating their balance sheets, although the volume of non-performing loans remained high in some countries.

Turning to households, their net wealth increased in the first three quarters of 2018, thus underpinning private consumption. In particular, continuous house price increases resulted in significant valuation gains on households’ real estate holdings. At the same time, decreases in share prices led to valuation losses on households’ financial asset holdings. While the annual growth rate of bank loans to households for house purchase remained moderate from a historical perspective, loan origination was strong.^[13] Household gross indebtedness – measured as a percentage of household nominal gross disposable income – stood well above its average pre-crisis level.

Overall, growth of loans to the private sector continued on the gradual upward trend observed since the beginning of 2014. The annual growth rate of MFI (monetary financial institution) loans to the private sector (adjusted for loan sales, securitisation and notional cash pooling) increased to 3.4% in December 2018, from 2.9% in December 2017 (see Chart 14). Credit growth therefore consolidated its role as a significant driver of broad money growth (see the blue parts of the bars in Chart 15), which nevertheless moderated compared with the steady pace of around 5% observed since mid-2015 (see Chart 14). Annual M3 growth stood at 4.1% in December 2018, compared with 4.6% at the end of 2017. The reduction in Eurosystem net asset purchases (from €80 billion to €60 billion in April 2017, to €30 billion in January 2018, to €15 billion in October 2018 and then to zero at the end of December 2018) has meant that the asset purchase programme had a smaller positive impact on M3 growth (see the red parts of the bars in Chart 15). At the same time, net government bond sales by euro area MFIs excluding the Eurosystem dampened M3 growth (see the light green parts of the bars in Chart 15). Despite the widening interest rate differential vis-à-vis non-euro area assets, the contribution from net external assets turned positive in net terms in October 2018 (see the yellow parts of the bars in Chart 15).

Growth in M3 continued to be driven by its most liquid components, given the low opportunity cost of holding liquid deposits in an environment characterised by very low interest rates and a flat yield curve. Growth in M1, which benefited from the elevated growth of overnight deposits held by both households and NFCs, declined as well and stood at 6.6% in December 2018, compared with 8.7% in December 2017.

2 Monetary policy: patience, prudence and persistence remain paramount

On the grounds of substantial progress towards a sustained adjustment in inflation, together with the underlying strength of the euro area economy and well-anchored inflation expectations, the monthly pace of net asset purchases under the asset purchase programme (APP) was gradually reduced throughout 2018 and the net purchases finished at the end of the year. Nevertheless, monetary policy remained patient, prudent and persistent and retained the ample degree of accommodation that was still needed to ensure the continued convergence of inflation to levels below, but close to, 2% over the medium term. Accommodation was provided by the residual net asset purchases, by the sizeable stock of acquired assets and the associated reinvestments, and by forward guidance on the key ECB interest rates, which remained at historical lows. At the end of 2018 monetary policy assets accounted for 72% of the Eurosystem’s balance sheet. The size of the balance sheet reached a historical high of €4.7 trillion. Risks related to the large balance sheet continued to be mitigated by the ECB risk management framework.

2.1 Winding-down of net asset purchases, while keeping policy accommodation ample

By the end of 2017 the euro area economy was experiencing an increasingly robust and broad-based economic expansion. Strong external demand contributed to growth, and increasing domestic demand underpinned the expansion, supported by employment gains, rising household wealth and corporate profitability, as well as very favourable financing conditions. Underlying price pressures remained subdued, but the steady absorption of economic slack gave grounds for increased confidence in a sustained adjustment in the path of inflation. On this basis, the Governing Council announced in October 2017 that it intended to reduce monthly purchase volumes under the APP from the beginning of 2018.

Accordingly, the monthly pace of net asset purchases under the APP was reduced from €60 billion to €30 billion as of January 2018. The Governing Council anticipated that the new monthly pace would run until the end of September 2018, or beyond, if necessary, and in any case until it saw a sustained adjustment in the path of inflation towards levels that are below, but close to, 2% over the medium term.

At the same time, the economic outlook and the path of inflation remained conditional on the continued support from the Governing Council’s policy measures. Monetary accommodation was provided by the ongoing net asset purchases. Moreover, the interest rate on the main refinancing operations and on the marginal lending facility and the deposit facility remained unchanged, at 0.00%, 0.25% and −0.40% respectively (see Chart 16). The monetary stimulus was further supported by the Governing Council’s forward guidance: key policy rates were expected to remain at their present levels for an extended period of time, and well past the horizon of net asset purchases. Additionally, the Governing Council intended to reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of net asset purchases, and in any case for as long as necessary.

Despite some moderation from the very strong growth performance in 2017 on account of a weakening in export demand, domestic demand remained solid, supporting the broad-based expansion of the euro area economy through the first half of 2018. While risks of heightened financial market volatility and uncertainties relating to global factors, including protectionism, had gained prominence, the risks surrounding the euro area growth outlook remained broadly balanced.

High levels of capacity utilisation, labour market tightness and rising wage growth supported the further build-up of domestic price pressures. Measures of underlying inflation remained generally muted, but had increased from earlier lows. The June 2018 Eurosystem staff macroeconomic projections were consistent with a gradual convergence of inflation towards levels below, but close to, 2% over the medium term. Meanwhile, uncertainty surrounding the inflation outlook had been receding significantly and the risk of deflation had disappeared.

At its June meeting, the Governing Council assessed that progress towards a sustained adjustment in inflation had been substantial. The underlying strength of the euro area economy along with well-anchored inflation expectations provided grounds for confidence that the sustained convergence of inflation would continue, even after a gradual winding-down of net asset purchases.

In this context, the Governing Council at its June meeting decided to confirm that the Eurosystem would continue to make net asset purchases under the APP at a monthly pace of €30 billion until the end of September 2018. It was anticipated that, after September 2018, subject to incoming data confirming the medium-term inflation outlook, net asset purchases would be reduced to €15 billion a month for the period from October to December. After December net asset purchases were anticipated to end.

At the same time, in the light of prevailing uncertainties, patience, prudence and persistence continued to be paramount as underlying price pressures remained contingent on a very substantial degree of monetary policy accommodation. Accordingly, credible and effective forward guidance on the use of the remaining policy instruments was provided as a means of further supporting the sustained convergence of inflation towards the ECB’s inflation aim:

• The Governing Council enhanced its forward guidance on the future path of policy rates: key policy rates were expected to remain at their then prevailing levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term. Adding an explicit date-based and state-contingent component to the guidance provided greater clarity on the future path of policy interest rates, thereby anchoring policy rate expectations more firmly to support the financial conditions underpinning a continued convergence of inflation towards the inflation aim. The state-contingent component of the forward guidance, explicitly linking a first policy rate rise to inflation evolving along a sustained adjustment path, was consistent with a forward-looking and medium-term-oriented monetary policy strategy and underscored the credibility of the Governing Council’s commitment to its price stability objective. At the same time, the enhanced rate forward guidance maintained adequate policy flexibility.
• Moreover, forward guidance on the reinvestment of the principal payments from maturing securities purchased under the APP was reconfirmed. The reinvestment horizon would continue for an extended period of time after the end of net asset purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

In the light of still prevailing uncertainties and only gradually rising underlying inflation, monetary policy had to remain patient, prudent and persistent. Even if the net flows under the APP were coming to an end, monetary policy would have to remain highly accommodative. Meanwhile, the June decision initiated a rotation from net asset purchases towards the policy interest rates and forward guidance on their likely future evolution as a means of steering the monetary policy stance. All in all, communication had to be carefully balanced between anticipating a termination of net asset purchases by the end of 2018 and highlighting the continued commitment to provide sufficient monetary stimulus for as long as necessary.

Throughout the autumn new information came in weaker than expected, reflecting softer external demand but also some country and sector-specific factors. While some of these factors were likely to unwind, others could indicate a moderation in the growth momentum. At the same time, the underlying strength of domestic demand continued to underpin the expansion of the euro area economy and gradually rising inflation pressures. Domestic cost pressures continued to strengthen and broaden, amid high levels of capacity utilisation and tightening labour markets, which pushed up wage growth. Overall, risks surrounding the growth outlook were still assessed as broadly balanced. Nevertheless, the balance of risks was moving to the downside owing to geopolitical factors, the threat of protectionism, vulnerabilities in emerging markets and financial market volatility, which had gained more prominence during the summer and remained prominent towards the end of the year.

In December, on the basis of incoming information, the Governing Council reviewed the economic outlook and concluded that the overall assessment broadly confirmed the outlook from June. The underlying strength of domestic demand continued to support confidence that the sustained convergence of inflation to the ECB’s aim was proceeding and would be maintained even after the end of net asset purchases. On this basis, the Governing Council found it appropriate to end net asset purchases under the APP in December 2018, as previously anticipated. At the same time, the continued inflation convergence still required monetary policy to be patient, prudent and persistent. Therefore, the forward guidance on reinvestment was enhanced. Accordingly, the Governing Council intended to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date when it starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation. Linking the reinvestment horizon to the interest rate lift-off confirmed that the key ECB interest rates and the associated forward guidance on their likely future evolution would remain the primary tool to adjust the monetary policy stance going forward. The rate forward guidance, reinforced by the reinvestments of the sizeable stock of acquired assets, would provide the necessary degree of accommodation for the sustained convergence of inflation towards levels that are below, but close to, 2% over the medium term.

Policy measures continued to ensure very favourable financing conditions and support the economic expansion

The implementation of the APP proceeded smoothly, both in the public sector purchase programme (PSPP) and in the private sector purchase programmes, encompassing the asset-backed securities purchase programme (ABSPP), the corporate sector purchase programme (CSPP) and the third covered bond purchase programme (CBPP3). Monthly net purchase volumes were, on average, in line with the monthly targets set by the Governing Council, at €30 billion per month from January to September and at €15 billion per month from October to December (see Chart 17). Net purchase volumes were below the monthly target in August due to seasonal fluctuations in market liquidity, but this was offset by slightly higher purchase volumes during the rest of the year. At the individual country level, redemptions of debt securities held in the various programme portfolios caused sizeable fluctuations in gross monthly purchases. Overall, net monthly purchases deviated only marginally from the target volumes in relative terms. The stock of PSPP holdings at year-end was broadly in line with the envisaged country allocation guided by the capital key. The implementation of the PSPP had not adversely affected euro area sovereign bond market liquidity conditions (see Box 2). The targeted longer-term refinancing operations (TLTROs) (see Section 2.2) contributed to favourable financing conditions, supporting the continued adjustment in the path of inflation.

The accommodative monetary policy stance and the strengthening of bank balance sheets continued to contribute to low bank funding costs. Despite an increase in the dispersion of funding costs across euro area countries in the second half of 2018, these costs remained well below the levels seen prior to the adoption of the ECB’s credit easing measures in June 2014 (see Chart 18). Banks’ very favourable financing conditions were passed on to the wider economy, with borrowing conditions for firms and households continuing to be attractive across the euro area. Bank lending rates for non-financial corporations (NFCs) and households remained close to their historical lows. Between the beginning of June 2014 and December 2018, they declined by around 130 and 110 basis points, respectively, which is significantly more than the change in market reference rates (see Chart 19).

Market-based funding costs for NFCs also remained very favourable, supported by the continued spread-compressing impact of the CSPP net purchases (see Box 3). Nevertheless, investment-grade NFC bond spreads widened gradually and steadily throughout 2018 from post-crisis lows due to increasing uncertainties surrounding the euro area and global growth outlook.

Credit flows to the private sector continued to benefit from the very favourable financing conditions. The growth in bank lending to NFCs and households continued on the gradual upward trend observed since the beginning of 2014 (see Section 1.4). Net debt securities issuance by NFCs continued to be supported by the CSPP despite moderating somewhat compared with last year (see Box 3). According to the ECB’s securities issues statistics^[18], net new issues denominated in euro amounted to €56 billion in the first eleven months of 2018, compared with €91 billion in the same period of 2017. Net new issues denominated in other currencies amounted to −€3 billion in the first eleven months of 2018, and −€7 billion in the same period of 2017, which is consistent with the CSPP providing an incentive to euro area NFCs to issue new debt in euro and redeem debt in other currencies.

Banks continued to report an easing of credit standards and overall terms and conditions on new loans, supported by the ECB’s monetary policy measures. According to the euro area bank lending survey, the APP continued to have an easing impact on banks’ overall terms and conditions on new loans to enterprises and households. Moreover, the ECB’s monetary policy measures had a positive impact on bank lending volumes. Low interest rates and the ongoing economic expansion in the euro area continued to support demand for credit (see Section 1.4). According to the latest Survey on the Access to Finance of Enterprises (SAFE)^[19], the availability and conditions of external financing for small and medium-sized enterprises (SMEs) further improved in 2018, supported by the substantial monetary policy accommodation and the enhanced financing conditions of SMEs (see Box 3).

The ample degree of monetary policy accommodation introduced since 2014 has contributed substantially to the improvement in the economic performance of the euro area, supporting the convergence of inflation towards the Governing Council’s inflation aim. Private consumption was supported by ongoing employment gains, which – in turn – partly reflected past labour market reforms, and by growing household wealth. Business investment was fostered by the favourable financing conditions, rising corporate profitability and solid demand. Housing investment remained robust. Considering all the monetary policy measures taken since mid-2014, the overall impact on euro area real GDP growth and euro area inflation is estimated to be – in both cases – around 1.9 percentage points cumulatively between 2016 and 2020.^[25]

2.2 Eurosystem balance sheet dynamics towards the end of net asset purchases

Since the onset of the global financial crisis in 2007-08 the Eurosystem has taken a variety of standard as well as non-standard monetary policy measures, which have had a direct impact on the size and composition of the Eurosystem’s balance sheet over time. The non-standard measures have included collateralised lending operations to provide funding to counterparties with an initial maturity of up to four years, as well as purchases of assets issued by private and public entities (under the APP), in order to improve the transmission of monetary policy and ease financing conditions in the euro area. Over the course of 2018 the Eurosystem’s balance sheet continued to grow on account of these non-standard policy measures and, by the end of 2018, its size had reached a historical high of €4.7 trillion, an increase of €0.2 trillion compared with the end of 2017.

The APP led to a further expansion of the Eurosystem’s balance sheet in 2018, although at a somewhat lower rate than in previous years as monthly net asset purchases were reduced (see Section 2.1). At the end of 2018 monetary policy-related items on the assets side amounted to €3.4 trillion, accounting for 72% of the total assets on the Eurosystem’s balance sheet (up from 70% at the end of 2017). These monetary policy-related assets include loans to euro area credit institutions, which accounted for 16% of total assets (down from 17% at the end of 2017), and assets purchased for monetary policy purposes, which represented around 56% of total assets (up from 53% at the end of 2017) (see Chart 20). Other financial assets on the balance sheet mainly consisted of: (i) foreign currency and gold held by the Eurosystem; (ii) euro-denominated non-monetary policy portfolios; and (iii) emergency liquidity assistance provided by some Eurosystem national central banks (NCBs) to solvent financial institutions facing temporary liquidity problems. These other financial assets are subject to internal Eurosystem reporting requirements and restrictions arising in particular from the monetary financing prohibition and the requirement that they should not interfere with monetary policy, which are set out in various legal texts.^[26]

On the liabilities side, the main impact of the continued accommodative monetary policy in 2018 was on counterparties’ reserve holdings and recourse to the deposit facility, which remained broadly unchanged at €2 trillion and represented 39% of the liabilities side at the end of 2018, down from 42% at the end of 2017. Banknotes in circulation grew in line with the historical growth trend, but remained unchanged in relative terms at 26% of liabilities compared with the end of 2017. Other liabilities, including capital and revaluation accounts, accounted for 34% (up from 32% at the end of 2017), and in absolute amounts they increased by €0.2 trillion (see Chart 20).

Average APP portfolio maturity and distribution across assets and jurisdictions

The monthly pace of net asset purchases was reduced from €30 billion as of January to €15 billion as of October 2018. At year-end APP holdings^[27] amounted to €2.6 trillion.^[28]

The ABSPP accounted for 1% (€28 billion), the CBPP3 accounted for 10% (€262 billion) and the CSPP accounted for 7% (€178 billion) of total APP holdings at year-end. Out of the private sector purchase programmes, the CSPP contributed the most to the growth in APP holdings in 2018, with €48 billion of net purchases. CSPP purchases are made based on a benchmark which reflects proportionally all eligible outstanding issues. This implies that market capitalisation provides a weighting for each of the different jurisdictions of issuance within the benchmark.

The PSPP accounted for the bulk of the APP, amounting to €2.1 trillion or 82% of total APP holdings at the end of 2018, compared with 83% at the end of 2017. Under the PSPP, the allocation of purchases to jurisdictions is guided by the ECB’s capital key. Within the individual allocations assigned to them, the ECB and the euro area NCBs have flexibility to choose between purchases of central, regional and local government securities, securities issued by certain agencies established in the respective jurisdictions and, if necessary, securities issued by supranational institutions. The weighted average maturity of the PSPP holdings stood at 7.4 years at the end of 2018, somewhat lower than the 7.7 years at the end of 2017, with some variation across jurisdictions.^[29]

The Eurosystem reinvests principal payments on the assets purchased under the APP as they mature. The reinvestments under the private sector purchase programmes amounted to €30.9 billion in 2018, while the reinvestments under the PSPP amounted to €116.7 billion.^[30] The assets purchased under the PSPP and CSPP continued to be made available for securities lending^[31], in order to support bond and repurchase agreement (repo) market liquidity.^[32]

Developments in Eurosystem refinancing operations

The outstanding amount of Eurosystem refinancing operations decreased by €30.6 billion since the end of 2017, standing at €733.4 billion at the end of 2018. This can be largely attributed to the voluntary repayments of €4.5 billion and the maturity of €8.9 billion of the TLTRO-I series, as well as to the voluntary repayments of €17.8 billion of the TLTRO-II series. The weighted average maturity of outstanding Eurosystem refinancing operations decreased from around 2.7 years at the end of 2017 to around 1.8 years at the end of 2018. The weighted average TLTRO-II interest rate was −0.3650% (rounded).

2.3 The risk management framework for the APP mitigates financial risks, while supporting the monetary policy objective

Three main principles guide asset purchases from a monetary policy perspective. First, the asset purchases should be an effective tool to achieve the ECB’s primary objective of maintaining price stability. Second, asset purchases should be proportionate to the policy objectives and market distortions should be avoided. Third, when there are several options to fulfil the policy objectives, the option selected should be efficient both from an operational as well as from a risk perspective. In that context, the Eurosystem’s risk management function endeavours to attain risk efficiency: achieving the policy objectives with the lowest amount of risk for the Eurosystem.^[33]

All monetary policy instruments, including outright asset purchases, inherently involve risks which are managed and controlled by the Eurosystem. These risks consist of credit, market, liquidity, operational and legal risks. The outright asset purchases require specific risk management frameworks to limit financial risks which depend on the specific policy objectives and on the features and risk profiles of the asset types involved. Each of these frameworks consists of eligibility criteria, credit assessment and due diligence procedures, pricing frameworks, benchmarks and limits. The risk control frameworks not only serve the purpose of mitigating financial risks, they also contribute to a successful achievement of the policy objectives by steering asset purchases towards a diversified market-neutral asset allocation. In the following, the risk management frameworks governing the implementation of the APP are described. Table 1 summarises the key elements of the frameworks. The risk management frameworks will continue to apply throughout the reinvestment period and for as long as APP holdings are on the Eurosystem’s balance sheet.

Eligibility requirements for outright asset purchases

Only marketable assets which are accepted as collateral for Eurosystem credit operations are eligible for outright asset purchases. The collateral eligibility criteria for Eurosystem credit operations are stated in the general framework for monetary policy instruments. Among other things, eligible assets are required to meet the criteria for credit quality step 3 (CQS 3) on the Eurosystem’s harmonised rating scale, e.g. having at least one credit rating^[34] provided by an external credit assessment institution (ECAI) accepted within the Eurosystem credit assessment framework (ECAF). Furthermore, assets must be euro-denominated and issued and settled in the euro area. In the case of asset-backed securities (ABSs), the debtors underlying the respective claims must be predominantly located in the euro area.

For assets issued or guaranteed by central governments, the minimum CQS 3 threshold can be waived if the respective jurisdiction is subject to and compliant with an EU/IMF programme as decided by the Governing Council. Assets that are eligible for purchase by virtue of a waiver of the minimum credit quality threshold must meet additional requirements. For example, purchases are not permitted during the review period of such a programme, and can resume only after a positive outcome of the review. For the ABSPP and the CBPP3, such assets must have the maximum achievable rating in the jurisdiction and meet other requirements to mitigate increased risk.

In addition to the eligibility criteria above, specific eligibility criteria apply depending on the programme. For instance, for the PSPP and the CSPP, there are minimum and maximum maturity restrictions in place.^[35] For the CSPP, assets issued by credit institutions, or by issuers for which the parent undertaking is a credit institution, are not eligible for purchase. Moreover, for the CSPP and the CBPP3, assets issued by wind-down entities and asset management companies are excluded from purchases. In the CBPP3, the assets must be eligible as collateral for Eurosystem credit operations and, in addition, fulfil the necessary conditions for their acceptance as own-use collateral, i.e. they can be used as collateral by the issuing credit institution.^[36] Furthermore, conditional pass-through covered bonds are not eligible for purchase from 1 January 2019. Finally, asset purchases must not circumvent the rules prohibiting the monetary financing of public authorities as set out in Article 123(1) of the Treaty on the Functioning of the European Union.

Credit risk assessment and due diligence

For the private sector purchase programmes, the Eurosystem conducts appropriate credit risk assessments and due diligence procedures on the purchasable universe on an ongoing basis. Monitoring frameworks are maintained using certain risk indicators. These assessments and procedures follow the principle of proportionality, where riskier assets are subject to more in-depth analysis. If warranted, additional risk management measures may apply, also subject to the principle of proportionality, in particular limitations on or suspension of purchases and, in extraordinary cases, even sales of assets, which require a case-by-case assessment by the Governing Council.

Pricing frameworks

The pricing frameworks for the APP ensure that purchases are made at market prices in order to minimise market distortions and facilitate the achievement of risk efficiency. These frameworks take into account available market prices, the quality of such prices and fair values. Ex post price checks are also conducted in order to assess if the transaction prices at which purchases were made reflected market prices at the time of the transactions.

Under the private sector purchase programmes, asset purchases at a negative yield are permissible if the yield is above the deposit facility rate. Purchases at yields below the deposit facility rate are permissible only under the public sector purchase programme and only to the extent necessary.^[37]

Benchmarks

Benchmarks are used to ensure the build-up of a diversified portfolio and contribute to mitigating risks. The benchmarks for the private sector purchase programmes are based on the market capitalisation of the purchasable universe, i.e. the nominal outstanding amounts of the eligible assets satisfying risk considerations. In the case of the PSPP, the ECB’s capital key guides purchases by defining the country allocations of purchases.

Limits

Limit frameworks are in place for the APP. The calibration of issue and issuer limits^[38] takes into account policy, operational, legal and risk management considerations. The limits are fine-tuned according to the asset class, with a distinction being made between public sector assets and private sector assets.

PSPP issue and issuer limits are applied to safeguard market functioning and price formation, to limit risk concentration and to ensure that the Eurosystem does not become a dominant creditor of euro area governments. The issue limit for the PSPP is set at 33% of the outstanding amount of the issue, subject to a case-by-case verification that it would not lead to the Eurosystem having a blocking minority for the purpose of collective action clauses (CACs).^[39] Otherwise, the issue limit is 25%. The issuer limit is set at 33% of the outstanding amount of eligible assets issued by the respective public institution.

For the private sector purchase programmes, the issue limit is set at the higher level of 70%.^[40] In the CSPP, lower issue limits apply in specific cases, for example for assets issued by public undertakings, which are dealt with in a manner consistent with the treatment under the PSPP. In addition to these issue limits, issuer limits are applied for the CBPP3 and the CSPP. Particularly for the CSPP, those issuer limits are defined based on a benchmark allocation related to an issuer group’s market capitalisation in order to ensure a diversified allocation of purchases. Moreover, lower limits may apply if warranted based on the outcome of the credit risk assessment and due diligence procedures, as explained above.

3 Euro area financial sector: increasing bank resilience amid risks

The risk environment confronting the euro area financial sector became more challenging during 2018. On the one hand, several factors supported the financial stability environment, including a growing economy and improving banking sector resilience. On the other hand, increasing downside risks to growth, not least due to increasing trade protectionism, and rising political and policy uncertainty, weighed on the financial stability environment in 2018. Strong risk-taking in financial and real estate markets continued to fuel the build-up of asset price vulnerabilities, while risks continued to build up in the growing non-bank financial sector. In this environment, euro area countries, in consultation with the ECB, implemented a number of macroprudential measures to mitigate and build up resilience to systemic risks. In addition, ECB Banking Supervision took microprudential actions and continued to contribute to a stable European banking sector and a level playing field for all banks in the euro area. Ten years after the outbreak of the global financial crisis, the main regulatory reforms that have contributed to building a more resilient financial sector are close to completion. However, while substantial progress has been made, more needs to be done. In this regard, in 2018 the ECB continued to contribute to the ongoing discussions on completing the banking union and the capital markets union, and also highlighted the importance of developing tools to mitigate risks in the non-bank financial sector.

3.1 The financial stability environment in 2018

The financial stability environment became more challenging in 2018, which was reflected in systemic stress indicators (see Chart 21). The analysis in 2018 highlighted that some developments supported financial stability, including a continued economic expansion (see Chapter 1) and improved bank resilience. However, high risk-taking activities in some financial market segments contributed to compressed global risk premia. Rising protectionism and renewed stress in emerging market economies produced bouts of volatility. In the European Union, growing uncertainties related to the Brexit process and stress in the Italian bond markets contributed to higher political and policy uncertainty.

In this environment, four key risks to euro area financial stability over a two-year horizon were identified and discussed in the ECB’s semi-annual Financial Stability Review.

The possibility of a disorderly increase in global risk premia constituted the first key risk to financial stability over the coming years. The main triggers that could bring about a disorderly increase in risk premia relate to both domestic and external factors. This includes disorderly market reactions to political or policy uncertainty, further stress in emerging market economies with possible spillovers to advanced economies and a sharp turnaround in US macro-financial prospects. Pockets of high asset price valuations and high correlations across global financial asset prices may amplify a potential pick-up in global risk premia.

The second key risk was related to debt sustainability concerns. Indicators of stress in the euro area sovereign bond markets picked up somewhat in mid-2018, reflecting political developments in Italy. The increases were, however, relatively moderate, indicating a contained spillover of stress to other euro area countries. Indebtedness across euro area sovereigns remained high and the debt ratio has continued to increase in several highly indebted countries in recent years. Furthermore, in some countries private sector debt levels remained high by both historical and international standards and were above thresholds ordinarily associated with a debt overhang, although debt dynamics continued to benefit from the strong cyclical momentum of the euro area economy combined with very favourable financing conditions.

Momentum was building up in real estate markets across the euro area during 2018. The robust dynamics of house prices continued to feed into mild signs of overvaluation in the euro area residential real estate markets as a whole amid marked cross-country differences. In the commercial real estate markets, price increases have significantly outpaced rental price growth in recent years. Hence, yields on prime commercial property have been on a declining trend, reaching a new low in the current cycle. The observed yield compression might be indicative of possible price overvaluation in commercial real estate markets. However, it should also be noted that there are initial signs of a more mature phase of the cycle.

The third key risk was related to the low profitability prospects of euro area banks and possible hampered bank intermediation capacity. Euro area banks’ profitability stabilised, with aggregate return on equity standing at 6.9% in the third quarter of 2018. Banks’ solvency positions remained fairly stable, with euro area significant institutions’ aggregate Common Equity Tier 1 ratio standing at 14.2% at the end of the third quarter of 2018, compared with 14.3% a year earlier.

Euro area banks’ stock prices fell by around 30% in 2018, reflecting higher political uncertainty and concerns about the external outlook. The drop in stock prices contributed to lower valuation ratios, with aggregate price-to-book ratios for the largest listed banks standing at 0.6 at the end of 2018.

The steady decline in the non-performing loans (NPLs) of euro area banks continued. Non-performing loans decreased by €94 billion in the first three quarters of the year and euro area significant institutions’ aggregate NPL ratio stood at 4.2%, down from 5.2% one year earlier. The NPL reduction process either accelerated or continued apace in the majority of high-NPL countries. A granular decomposition of changes in NPL ratios over this period shows that the bulk of the reductions in NPL ratios were linked to cures, liquidations and write-offs. At the same time, a more active secondary market for impaired assets also contributed significantly to NPL reductions. Across countries, disposal activity continued to be strongest in Italy and Spain. Notwithstanding the increase in transactions, liquidity in the secondary markets for NPLs continued to be afflicted by several types of market failure. NPL transaction platforms could help in overcoming market failures by offering the prospect of greater transparency in NPL markets, fostering wider investor participation and addressing coordination issues.^[41]

The fourth key risk was related to possible liquidity strains in the investment fund sector. Over the past ten years total assets in the euro area investment fund sector have more than doubled from €5.7 trillion at the end of 2008 to €13.8 trillion in June 2018. The investment fund sector now accounts for nearly 20% of total assets held by the euro area financial sector. Investment funds’ holdings of risky assets continued to grow in 2018. At the same time, their cash buffers declined, raising the sector’s vulnerability to potential shocks in global financial markets. Therefore, should large redemptions by investors take place, funds may need to liquidate relatively large parts of their portfolios, which could depress market prices. While existing rules in the EU provide a robust framework to address investor protection and fund-specific vulnerabilities, there are growing concerns over cyclical risks associated with increased liquidity risk-taking and a growing market footprint of the sector as a whole.

All in all, the four risks are all clearly intertwined and would, if they were to materialise, have the potential to be mutually reinforcing.

3.2 The ECB’s macroprudential policy function

The emergence of systemic risks in the financial system is addressed through macroprudential policies and the ECB has been assigned an important role and specific powers in this field (see the SSM Regulation). In particular, the ECB has been given the task of assessing macroprudential measures provided for by EU legislation and adopted by national authorities in countries subject to ECB Banking Supervision, and also has the power to top up such national measures in the banking sector. In response to the risk environment confronting the euro area in 2018, national authorities, in consultation with the ECB, implemented a number of macroprudential measures to mitigate and build up resilience to systemic risks, and to ensure that financial services continue to be provided effectively to the real economy.^[42]

Continued macroprudential efforts to preserve financial stability

In 2018 the ECB continued its extensive efforts in the field of macroprudential policy, making an important contribution to preserving financial stability. In addition to making substantial analytical efforts, the ECB provided a platform for regular joint risk assessments and policy coordination between the ECB and the national authorities in the euro area. The ECB and the national authorities also continued to engage in broad and open discussions on the use of macroprudential instruments, and on the development of methods for assessing different types of systemic risk. These efforts further improved the process and methods for assessing systemic risks and the adequacy of macroprudential policy measures in the euro area.

Furthermore, the ECB continued to enhance its communication on macroprudential policy issues, raising awareness by making the ECB’s ongoing work and thinking in this field more transparent. Besides speeches, press releases and other publications such as occasional papers, the ECB continued publishing its biannual Macroprudential Bulletin, which is an important communication tool for explaining the ECB’s macroprudential policy framework and decision-making procedures, as well as analytical advances and assessments in the field. The ECB also continued to publish on its website an overview of currently active macroprudential measures in countries subject to ECB Banking Supervision.

Macroprudential policy decisions during 2018

In line with its legal mandate, the ECB in 2018 assessed notifications by the national authorities in the euro area of 103 macroprudential policy decisions regarding instruments targeting cyclical and structural systemic risks, as well as other instruments under Article 458 of the Capital Requirements Regulation (CRR). Most notifications related to the setting of countercyclical capital buffers (CCyBs) or the identification of global and other systemically important institutions (G-SIIs and O-SIIs) and the calibration of their capital buffers. The Governing Council of the ECB did not object to any of the macroprudential policy decisions that national authorities notified during 2018.

All 19 euro area countries assess on a quarterly basis cyclical systemic risks and, with those assessments as input, set the level of their CCyB. During 2018 four countries increased their CCyB rate. Národná banka Slovenska decided to increase the CCyB rate from 0.5% to 1.25%, effective from 1 August 2018, and to then further increase it to 1.5%, as of 1 August 2019, citing that Slovakia was among the EU countries with the most dynamic credit growth, both in the corporate as well as the household sector. Moreover, Lietuvos bankas decided to raise the CCyB rate from 0.5%, effective from 31 December 2018, to 1%, as of 30 June 2019. The increase in the CCyB rate was not associated with excessive cyclical risk, but rather with a change in the bank’s guiding principles with regard to setting the CCyB rate (now set at a positive level in a moderate risk environment). The Central Bank of Ireland decided to activate the CCyB rate at 1% as of 1 July 2019, with the intention to establish a buffer sufficiently early in the cycle in order to effectively promote resilience, while also accounting for the relative sensitivity of the Irish macro-financial environment to external developments. Finally, the High Council for Financial Stability in France introduced a positive CCyB rate for the first time, set at 0.25% and applicable from 1 July 2019, to increase banks’ resilience against cyclical risks, referring to the favourable macroeconomic context and the continued acceleration of the financial cycle.

Regarding macroprudential instruments targeting structural systemic risks, the ECB assessed national authorities’ decisions on capital buffers for 106 O-SIIs^[43], as well as three decisions on systemic risk buffers. As for measures notified under Article 458 of the CRR, the High Council for Financial Stability in France decided to tighten large exposure limits applicable to highly indebted large domestic non-financial corporations in order to address risks emanating from the acceleration of the financial cycle and the continued upward trend in the debt of such corporations. Furthermore, the Nationale Bank van België/Banque Nationale de Belgique proposed a two-pronged measure to target real estate risks, consisting of a general risk weight add-on of five percentage points for the retail exposures of banks using the internal ratings-based (IRB) approach secured by domestic immovable property, as well as of an additional risk-sensitive element targeting the risk profile of each IRB bank’s mortgage portfolio. The measure is aimed at increasing IRB banks’ resilience to macroprudential risks stemming from developments in the real estate market and the increasing vulnerability of borrowers.

Cooperation with the European Systemic Risk Board

The ECB continued to provide analytical, statistical, logistical and administrative support to the European Systemic Risk Board (ESRB) Secretariat, which is in charge of the day-to-day business of the ESRB. The ESRB is responsible for the macroprudential oversight of the EU financial system and the prevention and mitigation of systemic risk.

The ECB regularly contributed to the ESRB’s ongoing identification and monitoring of potential systemic risks, as well as providing general support to research undertaken by the ESRB. For example, the ECB cooperated with the ESRB’s High-Level Task Force on Safe Assets, which was set up to investigate the practical considerations relating to sovereign bond-backed securities (SBBS). A report comprising two volumes conveying the Task Force’s main findings, as well as the technical analysis underpinning those findings, was published. In addition, the ECB contributed to a series of published working papers related to SBBS.

With respect to the EU non-bank financial sector, the ECB contributed to the drafting of the third issue of the EU Shadow Banking Monitor, which presents an overview of developments in the sector, with a focus on assessing potential risks to financial stability. Also in the non-banking sphere, the ECB contributed to the ESRB report on Macroprudential provisions, measures and instruments for insurance, which was published in November 2018. The report serves as an input to ongoing Solvency II discussions on strengthening the regulatory framework for insurers and reinsurers from a macroprudential perspective.

The ECB co-chaired an expert group tasked with replying to the EU Council request that the ESRB develop “macro-prudential approaches to prevent the emergence of system-wide NPL problems, while taking due consideration of procyclical effects of measures addressing NPLs’ stocks and potential effects on financial stability”. The published report identified drivers of system-wide increases in NPLs, concluding that no fundamental changes to the existing macroprudential toolkit seem to be required, but some refinements should be considered.

In addition, the ECB chaired the task force which prepared the ESRB’s adverse scenarios for the European Banking Authority’s 2018 EU-wide stress test and the European Insurance and Occupational Pensions Authority’s 2018 insurance stress test, as well as providing critical technical and modelling support. Furthermore, the ECB hosted the Annual Workshop on Stress Testing in December 2018.

Finally, the ECB continued to support the ESRB in its analytical work on the large-scale dataset available under the European Market Infrastructure Regulation. This work enabled a shift towards a daily collection, processing and analysis of the data. This analytical effort is now supporting the ESRB, and its advisory committees and their substructures, in performing a more comprehensive and timely monitoring of derivatives markets.

More detailed information on the ESRB can be found on its website and in its Annual Reports.

3.3 Microprudential activities to ensure the soundness of individual banks

Throughout 2018 ECB Banking Supervision continued to contribute to a stable European banking sector and a level playing field for all banks in the euro area. While banks in the euro area have increased their resilience over the past years, they still face considerable challenges.

One of the most pressing challenges faced by banks in the euro area is a lack of profits. And while the situation has generally improved, they remain under pressure to adjust their business models. They still need to find ways to become sustainably profitable throughout the economic cycle. In 2018 ECB Banking Supervision finalised and published a thematic review on profitability and business models. The review found that the situation differs widely across banks. It also found that banks’ strategic steering capabilities are an important factor influencing the profitability of banks. ECB Banking Supervision will continue to monitor the situation and challenge banks’ business models.

Next to profitability, legacy assets such as NPLs still pose a problem for the euro area banking sector. NPLs curb banks’ profits, make them less resilient and reduce their ability to finance the economy. While it is primarily a responsibility of the affected banks, resolving the problem has been a top priority of EU authorities (as evidenced by the EU Action plan to tackle NPLs in Europe) and of ECB Banking Supervision in particular. Already in March 2017 ECB Banking Supervision had published qualitative guidance on how to deal with NPLs. This guidance was supplemented in March 2018 by an addendum, which specifies the expectations for the provisioning of new NPLs. In July 2018 ECB Banking Supervision announced further steps in dealing with the stock of NPLs.

Throughout the year ECB Banking Supervision continued improving its tools and methods. Following public consultations (launched in March 2018), ECB Banking Supervision published, in November 2018, the final guides for banks on their internal capital and liquidity management (the Internal Capital Adequacy Assessment Process or ICAAP and the Internal Liquidity Adequacy Assessment Process or ILAAP). Linked to the ongoing Targeted Review of Internal Models, ECB Banking Supervision also published, after a public consultation, the first chapter of its guide to internal models in November 2018. Furthermore, it issued guides on the assessment of licence applications which also cover fintech credit institutions. Another guide published in September 2018 focuses on on-site inspections and internal model investigations. Its aim is to explain how such inspections are conducted. ECB Banking Supervision also contributed to the European Banking Authority’s stress test of European banks (see Box 4).

In 2018 ECB Banking Supervision was also involved in handling the failure of a significant euro area bank. This particular case highlighted the need to further harmonise the rules for dealing with failing banks. And while the ECB has no anti-money laundering powers, the case also highlighted the need for a more harmonised approach towards this issue at the European level.

More detailed information on ECB Banking Supervision can be found on its website and in the 2018 ECB Annual Report on supervisory activities.

3.4 The ECB’s contribution to strengthening the banking union and the capital markets union

Ten years after the outbreak of the global financial crisis, the main regulatory reforms that have contributed to building a more resilient financial sector are close to completion. While substantial progress has been made over the past decade, there are still a number of legal and institutional challenges that need to be overcome before European banks can operate within a truly integrated framework and users of financial services benefit from a more integrated single banking market. Further efforts are also needed to develop capital markets, while at the same time strengthening the regulatory and supervisory framework for the non-bank financial sector.

In 2018 the ECB continued to contribute to the ongoing discussions on completing the banking union and the capital markets union (CMU). Both initiatives contribute to the better functioning of EMU. Establishing a common backstop to the Single Resolution Fund (SRF) and a European deposit insurance scheme (EDIS) will facilitate deeper financial integration and increase the credibility of the banking union. More integrated financial markets will improve the efficiency of credit allocation, facilitate private risk sharing and help to diversify sources of financing for the real economy.

In June 2018 the Heads of State or Government of the 27 EU Member States agreed on a first set of decisions on the reform of EMU, including the completion of the banking union. They agreed that the European Stability Mechanism would provide the common backstop to the SRF. The terms of reference of the common backstop were subsequently endorsed in December 2018. Furthermore, they decided that work should start on a roadmap for beginning political negotiations on EDIS. In December 2018 they agreed to establish a high-level working group to work on the next steps on EDIS.

In its work on supporting EU fora in establishing a common backstop to the SRF, the ECB provided its views on the matter in its legal opinion on the European Commission’s proposal for a regulation on the establishment of the European Monetary Fund. In particular, the ECB stated that the backstop should support all possible measures taken by the SRB, including the provision of both solvency support and liquidity support to institutions under resolution. Moreover, the decision-making for disbursements by the backstop should be rapid and should not delay the adoption and execution of the SRB’s resolution decisions.

Furthermore, the ECB considers that the risk reduction which has taken place can facilitate progress in the political debate on EDIS. It is important that the June 2016 roadmap is followed as closely as possible in this respect. With regard to the conditions for actually implementing EDIS, the ECB believes that they would need to be commensurate with the degree of risk sharing in the first stage of EDIS. The ECB also clarified that when considering different design models for the first stage of EDIS, it would be preferable to set up a centralised fund in order to ensure that the system is endowed with robust financial resources and that the governance framework allows for swift and joint decision-making at the European level.

The ECB also continued to provide technical advice on EDIS. In particular, it presented its updated quantitative analysis on EDIS capacity^[45] to the Ad Hoc Working Party on the Strengthening of the Banking Union. This analysis finds that a fully funded European deposit insurance fund would be sufficient to cover payouts in a very severe shock. There would also be no unwarranted systematic cross-subsidisation within EDIS in the sense of some banking systems systematically contributing less than they would benefit from the fund, even when considering country-specific shocks.

Furthermore, the ECB closely followed and contributed to the related debate on risk-reduction measures. In line with the June 2016 Council conclusions, completing the banking union requires further steps in terms of reducing and sharing risks in the financial sector. Continued risk reduction is in the direct interest of the ECB as a central bank and banking supervisor in order to strengthen the resilience of the banking system and of the banking union overall. In 2018 the ECB contributed to the joint monitoring report on risk reduction, prepared together with the European Commission and the Single Resolution Board, which provided an updated assessment of how risks are evolving within the banking union. Speaking at the European University Institute in May 2018, the ECB President explained that the dichotomy between risk reduction and risk sharing that characterises the debate is in many ways artificial. With the right policy framework, these two goals are mutually reinforcing.

The ECB has been a strong supporter of the CMU project since its inception. As recalled in the ECB’s November 2018 Financial Stability Review, progress on the CMU project is needed as a fully fledged CMU has the potential to boost economic growth and can play a crucial role in strengthening the EU’s financial architecture and supervisory regime; in this regard, a larger role for the European Securities and Markets Authority would be essential for the implementation of a fully fledged CMU. The completion of the various legislative initiatives presented in the Commission’s CMU Action Plan is thus of key importance. In addition, the ECB’s May 2018 Financial integration in Europe report highlighted various avenues identified by ECB research which would render the CMU project even more powerful in terms of risk-sharing benefits. These avenues focus on the value of pension reforms and institutional investment, the value of stimulating financial literacy, and the value of making further progress in enhancing the harmonisation of European insolvency frameworks.

As reflected in the path set out in the Commission’s CMU Action Plan, the non-bank financial sector is likely to play an increasingly important role in financing the economy in the euro area. This development offers many opportunities for a more diversified financial system, but – as financial intermediation shifts from banks to non-bank financial institutions – existing risks may migrate and new risks may emerge. The ECB in 2018 therefore highlighted the importance of developing tools to mitigate risks in the non-bank financial sector. For instance, EU legislators should introduce macroprudential tools designed to address systemic risks related to liquidity mismatches and the use of leverage in investment funds.

4 Smooth functioning of market infrastructure and payments

The Eurosystem plays a central role in developing, operating and overseeing the market infrastructure that ensures the free flow of payments, securities and collateral across Europe. Since the launch of the euro in 1999, it has greatly contributed to reshaping and consolidating the infrastructure for large-value payments, for post-trading services for financial instruments and, most recently, for instant retail payment services. Furthermore, the Eurosystem monitors the evolution of the digital transformation process to ensure that the safety and efficiency of financial market infrastructures are maintained.

4.1 TARGET Services

The Eurosystem’s TARGET Services include three components: TARGET2, a real-time gross settlement system for euro payment transactions related to the Eurosystem’s monetary policy operations, as well as bank-to-bank and commercial transactions; TARGET2-Securities (T2S), a single platform for Europe-wide securities settlement; and TARGET Instant Payment Settlement (TIPS), which allows payment service providers to offer their customers the real-time transfer of funds around the clock, every day of the year. All three services settle in central bank money, thereby eliminating the credit risk in the settlement of the transactions.

More than 1,700 banks use TARGET2 to initiate transactions in euro, either on their own behalf or on behalf of their customers. Taking into account branches and subsidiaries, more than 52,000 banks worldwide can be reached via TARGET2. In 2018 TARGET2 processed on average 346,834 payments per day with an average daily volume of €1.7 trillion.

One year after the final wave of migration to T2S, the connection of the Danish krone to the settlement platform was an important milestone, as it marked the first time that a currency other than the euro has been made available for delivery-versus-payment settlement in T2S, making use of the multi-currency functionality of the platform. In 2018 T2S processed an average of 572,172 transactions per day with an average daily volume of €925.69 billion.

In November 2018 the Eurosystem launched TIPS, which offers final and irrevocable settlement of instant payments in euro at any time of day and on any day of the year in less than ten seconds. TIPS was developed to facilitate the pan-European reach of instant payments. It is based on SEPA Instant Credit Transfer (SCT Inst) – a scheme for pan-European instant payments which has already been adopted by more than 2,000 payment service providers in 16 countries. Furthermore, TIPS was developed as an extension of TARGET2, which already provides an extensive network of participants across Europe that can be leveraged by TIPS.

TIPS may ultimately have a wide reach and large scale, tapping into the established network of TARGET2 participants and addressable BICs. There are flexible options to interact with TIPS, so different kinds of users can access the platform via different functions.

4.2 Maintaining the safety and efficiency of financial infrastructure throughout the digital transformation process

While European integration has been progressing, financial market infrastructure and payments are subject to the comprehensive digital transformation process in the financial industry and in society at large. The Eurosystem has taken up this double challenge by fostering integration and innovation in its role as a catalyst. Furthermore, the Eurosystem promotes the safety and efficiency of market infrastructure and payments under its oversight mandate.

In the field of payments, the Eurosystem has continuously driven the process of European integration and innovation. An assessment of SEPA (Single Euro Payments Area) migration shows that the standardisation of euro credit transfers and direct debits has been successfully achieved and its impact on payments is positive. However, “IBAN discrimination”, i.e. the practice of creditors refusing to accept non-domestic payment accounts for direct debits, has not been completely eliminated yet. Further action is also required to develop electronic mandate solutions for SEPA direct debits, while SEPA for cards is yet to be completed. The ECB is encouraging European card schemes to foster interoperability and full pan-European reach, enabling any card to be used at any terminal.

Under the auspices of the Euro Retail Payments Board (ERPB) – a high-level forum chaired by the ECB that fosters the development of an integrated, innovative and competitive market for euro-denominated retail payments in the EU – work on cards standardisation continued, along with the promotion of retail payments innovation in instant payments, person-to-person mobile payments, and the accessibility of retail payment services.

In the area of payment initiation services, i.e. online services which access a user’s payment account to initiate the transfer of funds on the user’s behalf and with the user’s consent and authentication, the ERPB decided on a common set of technical, operational and business requirements for the efficient and pan-European provision of payment initiation services. In the area of e-invoicing, the ERPB focused on the adoption of an ISO 20022‑based request-to-pay message and on further harmonisation among electronic invoice presentment and payment (EIPP) service providers.

In the field of securities, the Eurosystem has continued to foster T2S and post-trade harmonisation by adapting its monitoring framework for post-trade harmonisation to take into account the completion of T2S migration. 85% of T2S markets comply with T2S harmonisation standards, but further work needs to be done at market level to increase compliance with T2S corporate action standards.

In the area of collateral management, the ECB has, together with key European financial market stakeholders, delivered a first set of harmonised business processes and workflows based on ISO 20022 messaging for collateral management. More specifically, a harmonisation report on triparty collateral management and a harmonisation report on corporate actions were published in 2018, and the ECB is counting on the support of market participants to implement the harmonisation proposals set out in these reports, in particular to support the development of the new Eurosystem Collateral Management System (ECMS).

In the field of fintech, research into the implications of distributed ledger technology (DLT) for Europe’s financial market infrastructure was deepened and expanded. In 2018 the joint research programme of the ECB and the Bank of Japan to assess the possible use of DLT for financial market infrastructures continued with the completion of Project Stella phase 2. A truly novel approach to achieving interoperability between ledgers was analysed which does not require a connection or institutional arrangements between ledgers.

To ensure the safety and efficiency of financial market infrastructures and payments, the Eurosystem sets out oversight objectives in specific oversight regulations, standards, guidelines and recommendations and conducts its oversight tasks by collecting relevant information, assessing the information against the oversight objectives, and inducing change where necessary. In 2018 the Eurosystem further strengthened its oversight through enhanced reporting of major incidents by payment service providers,^[46] payment systems and payment schemes.

Based on its ongoing monitoring of card fraud, the Eurosystem published its fifth report on card fraud in 2018. The report showed a trend reversal with a slight decrease in rates of fraud involving cards issued in SEPA and a steep drop in card fraud at ATMs. However, online fraud continues to rise (albeit at a lower rate than the number of card-not-present transactions), accounting for almost three-quarters of total card fraud.

With regard to the oversight of securities settlement systems, the ECB participates, together with the other central banks of the euro area, in the authorisation and regular review and monitoring of central securities depositories (CSDs) under the CSD Regulation as the central bank of issue for the euro. In 2018 the Eurosystem provided its opinion on the authorisation of five CSDs and an opinion on the authorisation of one CSD to provide banking-type ancillary services.

2018 saw the launch of the first comprehensive assessment of T2S in operation against the CPMI‑IOSCO Principles for financial market infrastructures. The assessment is being conducted by the Eurosystem in consultation with the T2S Cooperative Arrangement, which consists of overseers and supervisors of CSDs using T2S services, central banks of issue for currencies settled in T2S and the European Securities and Markets Authority.

With regard to central counterparties (CCPs), the Eurosystem has continued to contribute to the activities of the supervisory colleges established under the European Market Infrastructure Regulation (EMIR). The growing role of CCPs is enhancing the resilience of the financial system but is also concentrating liquidity risks, which may affect the money market and the smooth operation of payment systems and necessitate the provision of central bank liquidity, in particular under exceptional circumstances. The Eurosystem needs an appropriate framework to monitor, assess and, where necessary, address these risks, both within the EU and in third countries. This is particularly important in the light of the fact that a significant proportion of euro-denominated clearing activities is carried out in the United Kingdom. The adoption of a revised supervisory framework for CCPs therefore remains critically important and urgent.

5 Efforts to support market functioning, and financial services provided to other institutions

In response to increasing concerns regarding the viability of the euro overnight index average (EONIA), in 2017 the ECB started developing a new reference interest rate, the euro short-term rate (€STR), based entirely on money market statistical reporting (MMSR) data. The €STR methodology was published in June 2018 after receiving broad support in two public consultations and was subsequently recommended by the working group on euro risk-free rates as a replacement for EONIA. As a result, the €STR is expected to become one of the main reference rates in euro area markets.

The ECB is responsible for the administration of various financial operations on behalf of the EU. It also has an overall coordinating role in relation to the Eurosystem Reserve Management Services framework.

In order to promote the integrity and effective functioning of the wholesale foreign exchange market, a set of principles of good practice has been developed (see Box 5 at the end of this chapter).

5.1 The €STR, the new overnight reference rate for euro area money markets

As long as it has existed, the euro area financial market has relied on reference rates such as EONIA^[47]. EONIA is widely used as the underlying reference rate in a range of derivatives contracts, such as interest rate swaps, or as a way to determine future payments in a number of open contracts. EONIA is also widely used for the valuation of financial products (for discounting future cash flows), making it of great importance for the functioning of markets. Benchmarks like EONIA are also important for central banks, as they are an indicator of how the central bank’s monetary policy is affecting various market segments and is being transmitted to the rest of the economy.

In future, the use of EONIA in its current form will be prohibited as it does not meet the requirements of the EU Benchmarks Regulation (BMR). After consultation with the panel banks, the European Money Markets Institute (EMMI), the administrator of EONIA, announced in February 2018 that no change in EONIA’s methodology would be pursued. This means that a replacement for EONIA is urgently needed to preserve the smooth functioning of all markets that rely on the existence of a robust overnight rate.

In view of the uncertainty surrounding EONIA, the ECB announced in September 2017 that it would produce its own overnight interest rate, the euro short-term rate (€STR), based entirely on data readily available to the Eurosystem via the daily money market statistical reporting. The collection of data intended to support the Eurosystem in the implementation of monetary policy started in July 2016 on the basis of the Money Market Statistical Reporting Regulation. It benefits from the input of the 50 largest euro area banks as measured by balance sheet size, which report every business day by 07:00 CET all their transactions from the previous business day in the unsecured and secured money markets, the FX swap market and the overnight index swap (OIS) market.

The ECB embarked on the production of the €STR with the clear intention that it should have all the features needed by market participants. The ECB therefore aims to follow best practice for benchmark production as embodied in the IOSCO principles and will strive to achieve the greatest possible transparency in the design of the rate, which has benefited from input received in two public consultations. The first public consultation launched in November 2017 dealt with the scope of the €STR and its “underlying interest”, while the second public consultation launched in March 2018 covered the precise modalities of the rate calculation. The final methodology for the €STR was released in June 2018.

The design of the €STR also seeks to address some of the shortcomings of the current EONIA methodology, while remaining fairly simple and close to what market participants are accustomed to. Like EONIA, the €STR is an unsecured rate, which implies that its value reflects the pure cost of funds and is not affected by other considerations, such as collateral. Also like EONIA, the €STR is an overnight rate, which is the tenor of the bulk of unsecured market activity. There are, however, significant differences between EONIA and the €STR. While EONIA is an interbank lending rate, the €STR captures the borrowing activity of the MMSR reporting agents not only from other banks but also from other financial corporations, such as pension funds, insurers and asset managers, thereby taking into account the fact that pure interbank market activity has declined in importance in the euro wholesale unsecured money market. Furthermore, while EONIA is based on a voluntary panel of contributors, the size of which has declined over time, the €STR is based on data from statistical reporting with a much broader and stable base of reporting agents. As a result, the underlying volumes are higher than the volumes underpinning EONIA. €STR daily volumes average €32 billion and range from €16.5 billion to €44.1 billion and, on average, around 32 banks report data each day. Furthermore, the €STR exhibits lower volatility than EONIA and is less susceptible to idiosyncratic behaviour (see Chart 22).

There are two essential differences between EONIA and the €STR, which market participants should bear in mind and prepare for. First, in view of the different scope of EONIA and the €STR, in particular that the €STR is a borrowing rate, while EONIA is a lending rate from the reporting agent’s point of view, there is currently a spread of around nine basis points between EONIA and the €STR. Second, in view of the MMSR reporting cycle, which ends at 07:00 on the following business day, the €STR can only be published one business day after the trade date of the eligible transactions, while EONIA is published on the same business day. This implies that all users who currently rely on an overnight benchmark being available on the same day should prepare the technical and procedural changes needed to adjust to the publication time of the €STR.

The €STR will become available by October 2019, following the completion of a thorough internal testing of systems and procedures at Eurosystem level. Meanwhile, the ECB is updating the pre-€STR data series once every maintenance period. This series is intended to give the general public an idea of how the €STR would look and behave if it were already in production. It includes daily computations since March 2017, which will help ease the adoption of the €STR once it is in production.

In September 2018 a private sector working group on euro risk-free rates, established with the backing of the ECB, the European Securities and Markets Authority, the Belgian Financial Services and Markets Authority (FSMA) and the European Commission, recommended the €STR as the replacement rate for EONIA and also as a rate which may serve the construction of fall-backs in contracts that currently refer to the euro interbank offered rate (EURIBOR). This recommendation was made following a public consultation on the possible candidates, including both secured and unsecured rates. The consultation received a good number of responses and produced both (i) an affirmation of the quality of the analysis and (ii) clear guidance on the preferred risk-free rate. The €STR was seen as the most appropriate future euro risk-free rate, predominantly on the grounds of its unsecured nature, compilation methodology and low volatility, as well as the fact that it will be administered by the ECB, an EU institution.

The recommendation of the €STR as a euro risk-free rate is only the very first step in the complex process of replacing EONIA. In December 2018 the working group released a report on the possible transition options away from EONIA. The possible transition paths are constructed as a response to four key questions: (i) Will EONIA and the €STR be published in parallel or will the €STR succeed EONIA beyond the BMR transition date? (ii) Will EONIA and the €STR be independent rates or will the methodology of EONIA evolve to become dependent on the €STR beyond the BMR transition date? (iii) Can an EONIA‑€STR spread smooth the transition? (iv) Can the EONIA OIS and €STR OIS discounting curves coexist? The report recommends that EMMI, as the administrator of EONIA, should develop the current methodology of EONIA from being set by panel banks to being calculated as a fixed spread over the €STR for a limited period of time, until EONIA is discontinued. This would provide a stable platform to facilitate a progressive and smooth transition to the €STR.

As next steps, it is of critical importance that all EONIA users start transition planning. There are many steps that can already be taken ahead of the release of the €STR, for example: (i) increasing internal awareness of the risks of and exposures to products linked to EONIA; (ii) starting preparations by reviewing the stock of contracts and evaluating the impact of the transition away from EONIA; (iii) budgeting for possible changes in internal systems and valuation models, especially as regards clearers; and (iv) communicating actively with clients directly, participating in relevant fora, such as industry working groups and roundtables, and responding to public consultations. Successful transition depends on the preparedness of every party, so it is important that all users are made aware and there is broad and active participation in discussions and consultations.

5.2 Administration of borrowing and lending operations

The ECB is responsible for the administration of the borrowing and lending operations of the EU under the medium-term financial assistance (MTFA) facility^[48] and the European Financial Stabilisation Mechanism (EFSM)^[49]. In 2018 the ECB processed interest payments in relation to the loans under the MTFA. As at 31 December 2018 the total outstanding amount under this facility was €1.7 billion. In 2018 the ECB also processed various payments and interest payments in relation to the loans under the EFSM. As at 31 December 2018 the total outstanding amount under this mechanism was €46.8 billion.

Similarly, the ECB is responsible for the administration of certain payments arising in connection with the operations under the European Financial Stability Facility (EFSF)^[50] and the European Stability Mechanism (ESM)^[51]. In 2018 the ECB processed various interest and fee payments in relation to loans under the EFSF. The ECB also processed ESM member contributions and various interest and fee payments in relation to the loans under this mechanism.

Finally, the ECB is responsible for processing all payments in relation to the loan facility agreement for Greece.^[52] As at 31 December 2018 the total outstanding amount under this agreement was €52.9 billion.

5.3 Eurosystem Reserve Management Services

In 2018 a comprehensive set of financial services continued to be offered within the Eurosystem Reserve Management Services (ERMS) framework established in 2005 for the management of customers’ euro-denominated reserve assets. A number of Eurosystem NCBs (“the Eurosystem service providers”) offer the complete set of these services, under harmonised terms and conditions in line with general market standards, to central banks, to monetary authorities and government agencies located outside the euro area, and to international organisations. The ECB performs an overall coordinating role, promoting the smooth functioning of the framework and reporting to the Governing Council.

The number of customers maintaining an ERMS business relationship with the Eurosystem was 277 at the end of 2018, compared with 278 at the end of 2017. With regard to the services themselves, the total aggregated holdings (which include cash assets and securities holdings) managed within the ERMS framework increased by approximately 10% over the same period.

The ERMS legal framework was amended in 2018 to include several operational changes, clarify some aspects and address some suggestions from the ERMS Customer Survey conducted in 2017. To do so, in order to avoid a further amending legal act, all the amendments made to the ERMS legal framework have been consolidated in the new ECB Guideline on the Eurosystem’s provision of reserve management services in euro to central banks and countries located outside the euro area and to international organisations (Guideline ECB/2018/14 (recast)).

6 More banknotes, less counterfeits

The ECB and the euro area NCBs are responsible for issuing euro banknotes within the euro area and for maintaining confidence in the currency. The number and value of euro banknotes in circulation have been rising since their introduction in 2002, and at a faster pace than economic growth in recent years. Owing to a combination of factors, including enhanced security features in the new Europa series, cooperation with law enforcement, and communication and training efforts at European and national level, the number of counterfeits has further decreased to a very low level. The introduction of the new €100 and €200 banknotes with their new, innovative security features on 28 May 2019 will complete the Europa series.

6.1 Steady increase in banknote circulation

In 2018 the number and value of euro banknotes in circulation grew by around 5.6% and 5.2% respectively. At the end of the year there were 22.6 billion euro banknotes in circulation, with a total value of €1,231 billion (see Charts 23 and 24). The €100 banknote had the highest annual growth rate, reaching 6.9% in 2018. The total value of €100 banknotes in circulation at the end of 2018 stood at €280 billion, which is equal to the combined value of all euro banknote denominations in circulation in May 2002. Growth in the €50 banknote remained dynamic, at 6.3%.

It is estimated that, in terms of value, around one-third of the euro banknotes in circulation are held outside the euro area. These notes are predominantly held in neighbouring countries and are mainly the higher denominations. They are used as a store of value and for settling transactions in international markets.

Production of euro banknotes is shared among euro area NCBs, which were altogether allocated the production of around 4 billion banknotes in 2018.

The total number of euro coins in circulation increased by 3.7% in 2018, to 130.7 billion at the end of the year. The value of coins in circulation rose to €29.0 billion, 3.6% higher than at the end of 2017.

In 2018 euro area NCBs checked the authenticity and condition of some 31 billion banknotes, withdrawing around 5 billion from circulation as unfit. The Eurosystem also continued its efforts to help banknote equipment manufacturers to ensure that their machines meet the ECB’s standards for checking euro banknotes for authenticity and condition prior to recirculation. In 2018 credit institutions and other professional cash handlers checked some 37 billion euro banknotes for authenticity and condition using such machines. Information about the Eurosystem survey on cash services offered by credit institutions and the acceptance of cash payments by retailers can be found in Box 6 below.

6.2 Euro banknote counterfeiting remained low and declined further

The total number of counterfeit euro banknotes decreased further in 2018, with around 563,000 counterfeits being withdrawn from circulation. This development is the result of a combination of factors, including enhanced security features in the new Europa series, cooperation with law enforcement, and communication and training efforts at European and national level. Compared with the number of genuine euro banknotes in circulation, the proportion of counterfeits has further decreased and is very low. Long-term developments in the quantity of counterfeits removed from circulation are shown in Chart 25. Counterfeiters mainly target €20 and €50 banknotes, which together accounted for more than 80% of the total number of counterfeits seized in 2018. The share of counterfeit €20 banknotes declined further in 2018.

In spite of a decline in the deceptiveness of counterfeits withdrawn from circulation, the ECB continues to advise the public to remain alert to the possibility of fraud, to remember the “feel-look-tilt” test, and not to rely on just one security feature. In addition, training is offered to professional cash handlers on a continuous basis, both in Europe and beyond, and up-to-date information material is being made available to support the Eurosystem’s fight against counterfeiting. The ECB also cooperates with Europol, Interpol and the European Commission in pursuit of this goal.

6.3 €100 and €200 banknotes with enhanced security features unveiled

New €100 and €200 banknotes with enhanced security features were unveiled on 17 September 2018. After the €5, €10, €20 and €50 banknotes, the €100 and €200 banknotes are the last two denominations of the Europa series and will enter into circulation on 28 May 2019. This marks the completion of several years of preparation and cooperation within the Eurosystem.

The Governing Council of the ECB decided to exclude the €500 from the Europa series, taking into account concerns that this denomination could facilitate illicit activities. In view of the international role of the euro and the widespread trust in euro banknotes, the €500 will remain legal tender and can therefore continue to be used as a means of payment and store of value. Euro banknotes will always retain their value, as any euro banknote can be exchanged for an unlimited period of time at euro area NCBs.

The ECB and the euro area NCBs have been conducting an information campaign to prepare the general public and professional cash handlers for the introduction of the new €100 and €200 banknotes. Just like the other denominations, the new banknotes are easy to check using the “feel, look and tilt” method, but the two high-denomination banknotes also include new, innovative security features. In terms of value the €100 banknote is the second most used denomination (after the €50), and in terms of number in circulation it ranks third (after the €50 and €20 and ahead of the €5 and €10). The Eurosystem is supporting manufacturers and owners of banknote-handling machines and authentication devices in making preparations for the new banknotes. This includes facilitating equipment testing, the possibility to borrow non-issued banknotes of the Europa series from NCBs and publishing a list of banknote-processing machines which have successfully demonstrated that they can process the new Europa series banknotes.

7 Statistics

The ECB – assisted by the NCBs and, for tasks related to the Single Supervisory Mechanism (SSM), by the NCAs – develops, collects, compiles and disseminates a wide range of statistics which are needed to support the monetary policy of the euro area, the supervisory functions of the ECB, financial stability and various other tasks of the ESCB and the tasks of the ESRB. These statistics are also used by public authorities, financial market participants, the media and the general public, contributing to the fulfilment of the ECB’s transparency objective. The ESCB deepened further its cooperation with the European Statistical System, in particular in the reflections and initiatives on measuring globalisation and the activities of multinational enterprises. In 2018 the ESCB continued to provide regular euro area statistics in a smooth and timely manner. In addition, it devoted considerable effort to fulfilling new requirements for high-quality and more granular statistics at the country, sector and instrument level.

7.1 New and enhanced euro area statistics

The strategy of the ESCB and its Statistics Committee regarding the collection of data from banks is aimed at standardising and integrating existing ESCB statistical frameworks as far as possible across domains and countries. This approach will rely on clear and harmonised concepts, definitions and requirements, as well as on promoting data standardisation, which would help automate data processing and enhance data quality. Another important component of this strategy is the shift towards a more granular data collection, which allows the fulfilment of new data requirements in a more flexible and timely way, reducing the need for ad hoc requests. The main objectives of this approach are to increase the efficiency of reporting and reduce the burden on banks.

One element of this strategic approach – the ESCB Integrated Reporting Framework (IReF) – aims to integrate banks’ statistical reporting requirements into a single collection layer covering all of the ESCB’s data needs and requirements. The IReF would also include the transformation rules needed to produce the necessary monetary and financial aggregates fulfilling specific requirements, starting from the integrated collection layer. Another element – the Banks’ Integrated Reporting Dictionary (BIRD) – is an input layer which aims to help reporting agents to efficiently organise information stored in their internal systems. It would be complemented by transformation rules applied by banks to fulfil their reporting requirements. Once the IReF is in place, banks will be able to reuse the same set of transformation rules across all euro area countries. The collaborative approach with the banking industry followed by the ESCB is outlined in Box 7.

In line with the implementation of this strategy, in 2018 the ECB’s Directorate General Statistics delivered substantial granular datasets to allow flexible and in-depth multi-criteria analysis. One prominent example is the collection of granular credit and credit risk data under the AnaCredit framework, which started in 2018. AnaCredit is an initiative to collect detailed, timely and harmonised information on individual loans granted by credit institutions to corporates and other legal persons and make it available to users under the appropriate confidentiality rules. Its data model supports the swift derivation of countless combinations of granular data, providing greater flexibility for the analysis carried out by users in various areas of central banking and banking supervision and enhancing the value of such analysis, as well as enabling comparisons with aggregated statistics as part of data quality assurance. Once all euro area NCBs have started full reporting to AnaCredit, it is expected to collect data on around 50 million instruments each month.

Significant progress was also made on the Securities Holdings Statistics Group (SHSG). The SHS dataset is highly granular; data can even be broken down to the level of individual members of a limited list of banking groups (investors) and to the security (holdings). Among other things, this allows risks and spillovers in financial markets to be identified properly and flexibly. The collection of data on individual securities held by individual banking groups was extended to encompass more banking groups and more attributes. Starting from the third quarter of 2018, the enhanced reporting now covers all banking groups that are directly supervised by the ECB. Moreover, the new attributes are reported in line with the concepts of AnaCredit so that data on loans and securities can be combined and analysed jointly in a harmonised manner. Both AnaCredit and SHS granular datasets rely on a system of registers which hold complete, accurate and up-to-date information on institutional entities (Register of Institutions and Affiliates Data – RIAD) and financial instruments (Centralised Securities Database – CSDB); both registers were significantly enhanced during 2018.

Likewise, over the last year and as foreseen, the capacity of the ESCB’s RIAD, which is the shared dataset of reference data on legal and other statistical institutional units, has been extended to strengthen its support to business processes across the Eurosystem and the performance of the tasks of the ESCB and the SSM. Furthermore, in June 2018 the ECB published the RIAD Guideline (Guideline ECB/2018/16), which improves the coordination of the tasks that NCBs conduct with respect to the reporting of reference data to RIAD. In 2018 the ECB initiated an amendment to the Money Market Statistical Reporting Regulation (Regulation ECB/2014/48). The amended Regulation will ensure that transactions with all financial counterparties are covered, strengthen the use of the Legal Entity Identifier (LEI), and firm up the obligations of reporting agents to meet high standards designed to protect the integrity of the information. Following two public consultations, the ECB announced the methodology for calculating the euro short-term rate (€STR) on 28 June 2018 (see Section 5.1). Publication of the €STR will begin by October 2019. Meanwhile, the ECB has started publishing figures (referred to as the pre-€STR) which market participants can use to assess the suitability of the new rate in advance of it becoming available, and adjust their processes and procedures to ensure a seamless transition. The pre-€STR includes daily historical time-series data from 15 March 2017 onwards.

In order to remain fit for purpose and meet users’ needs in a changing world, ECB macro statistics are also continuously evolving. A new ECB Regulation on statistical reporting requirements for pension funds (Regulation ECB/2018/2) was published on 17 February 2018. It is aimed at increasing transparency and improving data comparability in this fast-growing sector of the financial industry. The Regulation will remedy shortcomings of the current unharmonised and incomplete quarterly statistics on pension funds published since June 2011, in particular the limited dissemination of transaction data due to insufficient data quality.

The ECB Guideline on monetary and financial statistics was amended in 2018 (Guideline ECB/2018/17). It now provides for the transmission of further data to the ECB to the extent they are available in NCBs. These data include monthly data on the adjustment of monetary financial institution (MFI) loans to take into account activities related to loan sales and securitisation, notional cash pooling, MFI positions vis-à-vis the Single Resolution Board, a breakdown of MFI capital and reserves into sub-categories, and data identifying undertakings for collective investment in transferable securities within investment fund statistics.

The ECB Guideline on external statistics was also amended (Guideline ECB/2018/19) to address new analytical requirements in the area of monetary policy and financial stability, including to support further integration between quarterly balance of payments and international investment position statistics and national (including sectoral) accounts. The main changes result in additional sectoral and geographical detail. These data will be reported from March 2021 onwards.

Macroeconomic statistics may greatly benefit from newly developed granular databases in a number of ways. Linking macro data and granular data may enhance the quality of statistics, provide new statistical outputs and improve analytical flexibility. In this context, the ECB proceeded with its project linking micro data (Household Finance and Consumption Survey) and macro data (Sector Accounts) on households’ assets and liabilities. The aim is to develop macroeconomic information on the distribution of wealth and debt in the household sector, providing new and valuable information for economic analysis.

Joint analysis of near-time micro data integrated across market segments opens the way to analysing more complex, unforeseen and fast-evolving market behaviours in near time. To facilitate such progress, the ECB has stepped up its engagement and leadership in global data standardisation efforts, such as the now operational Global Legal Entity Identifier System, which needs to be developed to full coverage, and the development of ISO standards. Finally, ongoing efforts towards standardisation of data in the markets will improve the quality of the body of data collected, while reducing operational costs and risks for all.

7.2 Enhanced transparency and communication

In 2018 the ECB continued its efforts to enhance its own transparency by making its statistics more accessible, user-friendly and interactive for external professional users and the general public. In line with the ECB initiative of being “mobile first”, all statistical press releases have been enhanced in web formats, allowing easier access to statistics and the sharing of statistics on social media. While ECB statistics are available via its improved statistical flagship, the Statistical Data Warehouse, new statistical narratives and visualisations of euro area and comparable national statistics have been released on the “Our statistics” website. Professional users, such as journalists, can reuse the visualisations in their own newsfeeds or on their websites using their preferred EU language.

Supervisory banking statistics have also evolved in response to the changes in the market and the regulatory environment and to address requests and feedback received from users. The ECB collects and publishes quarterly supervisory banking statistics on institutions directly supervised by the ECB. The data include information on balance sheet composition and profitability, capital adequacy, leverage, funding and liquidity. Starting from the third quarter of 2018, coverage was extended to include exposures to general government, fair value hierarchy asset breakdowns and internal ratings-based credit risk parameters. In addition, in 2018 the ECB published for the first time individual Pillar 3 information on risk-weighted assets by risk type and by computational method for ECB-supervised global systemically important institutions (G‑SIIs) and other systemically important institutions (O‑SIIs) (75 institutions), in addition to the three solvency and leverage ratios for 118 significant institutions. This new level of transparency allows stakeholders to perform meaningful comparisons of prudential metrics. In 2018 the ECB improved the communication with the banking industry about the data quality process for supervisory data. Representatives of the banking sector were invited to discuss the development of additional quality checks applied to SSM data. For the sake of transparency, a first list of these checks has been published on the ECB’s and NCAs’ websites.

The ECB was also one of the co-organisers of the biannual “Conference of European Statistics Stakeholders 2018” in Bamberg, Germany, which offered opportunities for networking and discussion about statistical methodology among stakeholders of European statistics from science, academia, producers of statistics and societal groups. The ECB also celebrated the first 20 years of ESCB statistics with a conference entitled “Ninth ECB Statistics Conference – 20 years of ESCB statistics: What’s next?” (see Box 8).

8 ECB research priorities

Research priorities at the ECB are regularly reviewed and adjusted with the aim of providing sound analytical foundations for addressing the challenges faced by ECB policymakers. Collaboration across the ESCB is fostered by the ongoing activities of three research clusters and two research networks. In an environment characterised by negative policy rates, the transmission of non-standard monetary policy measures and the interplay between monetary policy, financial stability and the real sectors of the economy remained at the core of the 2018 research priorities. Studies assessed the effects of non-standard measures in counterbalancing the economic consequences of adverse financial shocks by reducing market uncertainty and improving access to bank finance for small and medium-sized firms. With the macroprudential policy framework in place, a new research task force was set up to study the interaction between monetary and macroprudential policies and their optimal coordination. Other priorities were the role played by financial factors in firm and household behaviour in the euro area, price and wage-setting dynamics, and the design of institutional and policy arrangements to strengthen EMU. The role of financial frictions in the propagation of monetary policy and economic shocks features prominently in a new version of the ECB’s Area-Wide Model and the further development of multi-country models used for forecasting and monetary policy analysis.^[53]

8.1 Activities of the ESCB research clusters and the PRISMA project

To further enhance collaboration among ESCB researchers, the Heads of ESCB Research Departments decided in 2016 to launch three research clusters. The purpose of the clusters is to coordinate efforts in high-priority research fields via workshops and joint research projects (see Figure 2).

In 2018 the research clusters organised a number of workshops, with research teams addressing issues such as the optimal design of monetary policy under uncertainty, financial market imperfections, and international spillovers. In relation to financial stability, one workshop discussed the implications of bank capital and liquidity requirements for bank behaviour and money markets. Another research strand focused on the microeconomic determinants of productivity growth, in particular the role of financial frictions, credit misallocation and the organisation of production. The preliminary results highlighted that it is important to take into account the role of small firms in order to understand the patterns of aggregate productivity growth.

Among the Eurosystem/ESCB research networks, the Household Finance and Consumption Network (HFCN) continued its work on the third wave of the Household Finance and Consumption Survey, the results of which are planned to be released in 2019. HFCN research has, among other things, studied the implications of household heterogeneity for monetary policy transmission. For example, researchers from the HFCN have quantified how monetary policy affects the consumption of individual households depending on their employment status and the structure of their portfolios. The finding that monetary policy disproportionately affects employment in the lower parts of the income distribution implies that expansionary monetary policy in the euro area has led to a reduction of inequality in income and consumption. Research of the network has also progressed in areas such as the effects of uncertainty on household decisions, the financial fragility of households, and the measurement of the upper tail of the wealth distribution. In addition, the survey has also been extensively used by external researchers.

PRISMA (price-setting micro data analysis), a new ESCB research network established in 2018 with a mandate from the Governing Council, will study price-setting behaviour of individual firms and in the retail sector using micro price datasets. Research will address the relationship between price setting and aggregate inflation dynamics. In particular, it will be studied whether price-setting behaviour has changed in the period of low inflation and is affected by the monetary stance, the state of the business cycle and the type of aggregate shocks affecting the economy.

With a macroprudential policy framework now in place, a new research task force was set up to study the interaction between monetary and macroprudential policies. One focus of the task force is on the various spillovers between the two policies, including the effects of monetary policy on financial stability and the impact of macroprudential policy measures on the real economy. Given these spillovers, a second focus is on the optimal coordination between the two policies.

8.2 Conferences and publications

In order to maintain its extensive dialogue with economists in academia and other policy institutions, the ECB organised several high-level research events in 2018, including the ECB Forum on Central Banking in Sintra and the ECB’s second Annual Research Conference (ARC). The former conference focused on the origins and implications of the low inflation dynamics that characterised the post-crisis recoveries in many advanced economies, including price and wage setting and the role of inflation expectations. ARC 2018 featured innovative research on topics such as the role of asset markets in signalling monetary policy, mortgage markets, the evolution of competitiveness in financial and goods markets, and globalisation. Other important conferences related to structural reforms in the euro area, global trade, labour markets and digitalisation, and monetary and macroprudential policies.^[54]

Many of the ECB’s research activities also resulted in the publication of papers in scientific journals and working papers. In 2018, 98 papers prepared by ECB staff were published in the ECB’s Working Paper Series. In addition, a number of more policy-oriented analytical studies were published via the ECB’s Occasional Paper Series, Statistics Paper Series and Discussion Paper Series. This pool of high-quality research provided the basis for an enhanced communication of ECB research findings to a wider audience, with 12 articles being published in the ECB’s Research Bulletin during 2018.^[55]

9 Legal activities and duties

This chapter deals with the jurisdiction of the Court of Justice of the European Union concerning the ECB, reports on ECB opinions and cases of non-compliance with the obligation to consult the ECB on draft legislation falling within its fields of competence, as well as monitoring compliance with the prohibition of monetary financing and privileged access.

9.1 Jurisdiction of the Court of Justice of the European Union concerning the ECB

In March 2018 the General Court of the European Union (the “General Court”) dismissed the action for damages brought by a private law-governed association of pensioners (ESTAMEDE) against the ECB in Case T‑124/17. Members of ESTAMEDE are beneficiaries of the Greek Pension Fund for Engineers and Public Works Contractors. The damages claimed related to the haircut affecting certain Greek government bonds in the context of a partial restructuring of Greece’s sovereign debt in 2012 allegedly suffered by the pension fund and its beneficiaries and not by the association itself. The application attempted to attribute to the ECB various breaches of EU law and principles, including fundamental rights protected by the EU Charter of Fundamental Rights such as the right to property. With its order, the General Court dismissed the action as manifestly inadmissible, without examining the substance of the case, thus excluding any liability of the ECB for the damages claimed. The General Court held that the applicant lacked standing before the General Court and the application failed to fulfil the formal requirements of admissibility.

In July 2018 the General Court also dismissed the actions for damages brought against, amongst others, the ECB by some depositors, shareholders and bondholders in the Cypriot banks which were subject to the 2013 resolution measures (Cases T‑680/13 and T‑786/14). The judgements follow the 2016 decisions of the Court of Justice of the European Union (the “Court of Justice”) in two appeal cases (the Mallis^[56] and Ledra^[57] cases) that concerned similar subject matters. The applicants alleged that the relevant resolution measures were imposed by the ECB and other defendants through, among others, their involvement in the Eurogroup meetings, their role in the negotiation and adoption of the Cypriot Memorandum of Understanding, and the ECB Governing Council decisions relating to the emergency liquidity assistance. The General Court found that the ECB and other defendants did not commit any breach of the right to property, the principle of legitimate expectations or the principle of equal treatment. The two judgements have been appealed before the Court of Justice.

In December 2018 the Court of Justice decided that consideration of the questions referred for a preliminary ruling by the German Federal Constitutional Court in Case C‑493/17 (Weiss) has revealed no factor of such a kind as to affect the validity of the ECB’s secondary markets public sector purchase programme (the “PSPP”). First, the PSPP falls within the area of monetary policy and observes the principle of proportionality. The PSPP’s specific objective can be attached to the primary objective of the Union’s monetary policy, the specification of which in quantitative terms as the maintenance of inflation rates at levels below, but close to, 2% over the medium term does not appear to be vitiated by a manifest error of assessment or to go beyond the framework established by the Treaties. In addition, the ECB weighed up the various interests involved so as to actually prevent disadvantages which are manifestly disproportionate to the PSPP’s objective from arising on implementation of the programme. In view of the risks to which the substantial volume of asset purchases under the PSPP might possibly expose the NCBs, the ECB decided against a general rule on loss sharing. Second, the PSPP is compatible with the prohibition of monetary financing. The fact that the PSPP makes it possible to foresee, at macroeconomic level, that a significant volume of bonds will be purchased on the secondary markets does not afford a given private operator such certainty that he can act, de facto, as an intermediary of the Eurosystem for the direct purchase of bonds from public authorities and bodies of Member States. Moreover, that macroeconomic foreseeability does not reduce the impetus of Member States to pursue a sound budgetary policy given the temporary and contingent nature of the programme and a series of safeguards that limit the effects of the PSPP on that impetus. The Court of Justice also stated that the prohibition of monetary financing does not preclude either the holding of bonds until maturity or the purchase of bonds with a negative yield to maturity. On the basis of this preliminary ruling, the German Federal Constitutional Court will decide on the constitutional complaints indirectly challenging the PSPP.

9.2 ECB opinions and cases of non-compliance

Articles 127(4) and 282(5) of the Treaty on the Functioning of the European Union require that the ECB be consulted on any proposed EU or draft national legislation falling within its fields of competence. All ECB opinions are published on the ECB’s website. ECB opinions on proposed EU legislation are also published in the Official Journal of the European Union.

In 2018 the ECB adopted 16 opinions on proposed Union acts and 42 opinions on draft national legislation falling within its fields of competence.

At the EU level, the ECB adopted opinions on proposed legislation relating to macro- and microprudential supervisory matters, including the reform of the European Systemic Risk Board^[58], the European Banking Authority^[59] and the European Securities and Markets Authority^[60], the capital treatment of non-performing exposures and covered bonds^[61], the prudential treatment of investment firms^[62] and strengthening the role of the European Banking Authority in the prevention of the use of the financial system for money laundering or terrorist financing^[63]. The ECB adopted opinions on other proposed Union legislation impacting financial markets, including the reform of covered bond markets^[64], the regulation of credit servicers, credit purchasers and the recovery of collateral^[65], charges applicable to cross-border payments and currency conversions^[66] and the law applicable to the third-party effects of assignments of claims^[67]. The ECB also issued opinions on the framework governing EMU, including strengthening fiscal responsibility and the medium-term budgetary orientation in the Member States^[68] and the proposed establishment of a European Investment Stabilisation Function^[69] and a European Monetary Fund^[70]. The ECB also opined on European business statistics^[71] and the EU “Pericles IV” anti-counterfeiting training programme^[72].

The ECB adopted opinions on draft national legislation concerning NCBs, including the governance and financial independence of the Central Bank of Cyprus^[73], the institutional independence of Българска народна банка (Bulgarian National Bank)^[74], the State audit of Hrvatska narodna banka^[75], the liability regime concerning the Board members and employees of Banca Naţională a României^[76], the minimum reserve requirements of Magyar Nemzeti Bank^[77] and the conferral of a wide variety of tasks on NCBs relating to matters such as supervising compliance with interchange fees for card-based payment transactions^[78], the security and protection of critical infrastructures^[79], the security of network and information systems in the financial sector^[80], securitisation activities^[81], the issuance of covered bonds^[82], the procedures for the conversion of Swiss franc-denominated loans into euro-denominated loans^[83], credit institutions’ activities pertaining to markets in financial instruments^[84], credit institutions’ key information documents for packaged retail and insurance-based investment products^[85], powers to conduct inquiries and take enforcement measures in response to the provision of false or misleading information by credit and financial institutions^[86], tasks regarding the regulation of certain savings accounts^[87], cooperating with competent authorities in relation to the return of funds from designated tax havens^[88], the maintenance of a central register of bank accounts and financial transactions^[89] and a national insurance claims database^[90]. A recurring theme in a number of these opinions was the assessment of the conferral of new tasks on NCBs against the prohibition of monetary financing under Article 123 of the Treaty in view of central bank financing of the performance of government tasks.

The ECB also issued opinions on draft national laws concerning the macro- and microprudential supervision of credit and financial institutions, including the establishment of close cooperation between the ECB and Българска народна банка (Bulgarian National Bank)^[91], the reform of the Italian popolari banks and cooperative banks^[92], macroprudential tools in Spain^[93], the macroprudential mandate of the central bank and the governance of credit institutions in Bulgaria^[94], macroprudential tools to remedy imbalances in the residential real estate sector and the reciprocal implementation of macroprudential tools in Luxembourg^[95], the introduction of an interbank funding ratio in Hungary^[96], mortgage amortisation requirements in Sweden^[97], the fixed remuneration of directors of systemically relevant credit institutions in the Netherlands^[98], the transmission of supervisory data for statistical purposes in Germany^[99], the reorganisation of the Polish Financial Services Authority^[100], and the funding sources and governance of the Malta Financial Services Authority^[101].

The ECB adopted opinions on other draft national laws impacting credit and financial institutions, including the framework for mortgage arrears resolution and the regulation of the business of owning credit agreements in Ireland^[102], the legal framework for covered bonds in the Czech Republic and Slovakia^[103], the framework for securitisations in Cyprus^[104], the conversion of Swiss franc loans into euro loans in Slovenia^[105], the remuneration formula of certain French regulated savings accounts^[106], and the preparedness obligations of the Finnish financial sector in a contingency/emergency situation^[107].

Reflecting the growing importance of cybersecurity issues, the ECB issued opinions to a number of Member States on the impact of national legislation related to information and cybersecurity on critical market infrastructures and the prudential supervision of credit institutions^[108]. The ECB also opined on new rounding rules for payments denominated in euro in Belgium^[109].

One case of non-compliance with the obligation to consult the ECB on proposed Union legislation was recorded. The ECB was not consulted on the proposal for a regulation of the European Parliament and of the Council on the law applicable to the third-party effects of assignments of claims. The ECB issued an own-initiative opinion in that case noting the shortcomings of the proposed choice of the law governing the third-party effects of assignments of claims^[110]. This non-consultation case is considered as a “clear and important” case of a failure to consult the ECB. The two non-compliance cases of 2017, together with the non-compliance case identified in 2018, are considered “clear and repetitive”.

In 2018 one horizontal issue was identified regarding the national laws implementing Directive (EU) 2016/1148 of the European Parliament and of the Council of 6 July 2016 concerning measures for a high common level of security of network and information systems across the Union. As a consequence of the discretion in the transposition of this Directive exercised by certain Member States, the ECB is currently assessing the extent to which its fields of advisory competence have been materially affected so far as concerns the NCBs, payment and settlement systems and/or the ECB’s tasks concerning the prudential supervision of credit institutions. To date, the ECB has issued one non-consultation letter to a national authority with respect to this matter (Cyprus). Furthermore, the ECB was not consulted by the Romanian authorities on a Government Emergency Ordinance introducing a tax on bank assets.

9.3 Compliance with the prohibition of monetary financing and privileged access

Pursuant to Article 271(d) of the Treaty on the Functioning of the European Union, the ECB is entrusted with the task of monitoring the compliance of the EU national central banks (NCBs) and the ECB with the prohibitions implied by Articles 123 and 124 of the Treaty and Council Regulations (EC) Nos 3603/93 and 3604/93. Article 123 prohibits the ECB and the NCBs from providing overdraft facilities or any other type of credit facility to governments and EU institutions or bodies, as well as from purchasing in the primary market debt instruments issued by these institutions. Article 124 prohibits any measure, not based on prudential considerations, which establishes privileged access by governments and EU institutions or bodies to financial institutions. In parallel with the Governing Council, the European Commission monitors Member States’ compliance with the above provisions.

The ECB also monitors the EU central banks’ secondary market purchases of debt instruments issued by the domestic public sector, the public sector of other Member States and EU institutions and bodies. According to the recitals of Council Regulation (EC) No 3603/93, the acquisition of public sector debt instruments in the secondary market must not be used to circumvent the objective of Article 123 of the Treaty. Such purchases should not become a form of indirect monetary financing of the public sector.

The monitoring exercise conducted for 2018 confirms that the provisions of Articles 123 and 124 of the Treaty and the related Council Regulations were in general respected.

The monitoring exercise revealed that most EU NCBs in 2018 had remuneration policies for public sector deposits in place that fully complied with the remuneration ceilings. However, a few NCBs need to ensure that the remuneration rate for public sector deposits is not above the ceiling.

The ECB’s 2016 Annual Report stated that the establishment and funding of MARK Zrt., an asset management company, by the Magyar Nemzeti Bank constituted a violation of the monetary financing prohibition that needed to be corrected. Following the completion of the necessary corrective actions by the Magyar Nemzeti Bank, the case has been closed.

Following up on the concerns raised in the ECB’s Annual Reports as of 2014, the ECB has continued to monitor several programmes launched by the Magyar Nemzeti Bank in 2014 and 2015. The Magyar Nemzeti Bank in 2018 continued taking actions to alleviate the ECB’s concerns and closed a programme of purchases of Hungarian artworks and cultural properties in 2018. However, in view of their multitude, scope and size, the ECB will continue to closely monitor compliance of these operations with the prohibition of monetary financing and of privileged access. Moreover, the ECB will continue monitoring the involvement of the Magyar Nemzeti Bank in the Budapest Stock Exchange as the purchase of the majority ownership of the Budapest Stock Exchange by the Magyar Nemzeti Bank in November 2015 may still be seen as giving rise to monetary financing concerns.

The reduction of IBRC-related assets by the Central Bank of Ireland during 2018 through sales of long-duration floating rate notes is a significant step in the direction of the necessary full disposal of these assets. A more ambitious sales schedule would further mitigate the persisting serious monetary financing concerns.

10 Key issues on the European and international agenda

In 2018 the ECB maintained its close dialogue with various European fora and institutions, including the European Council, the ECOFIN Council, the Eurogroup, the European Parliament and the European Commission. The economic outlook, deepening EMU and matters related to the EU fiscal and economic governance framework were among the topics discussed at European Council, Eurogroup and ECOFIN Council meetings in which the President of the ECB and other members of the Executive Board took part.

10.1 Deepening EMU

In 2018 the ECB took part in discussions on strengthening EMU, providing technical advice in its areas of competence and expertise. Discussions in EU fora focused on three main issues: completion of the banking union, reform of the European Stability Mechanism (ESM) and the design of a euro area instrument for macroeconomic stabilisation. Key inputs for this debate included a reflection paper published by the European Commission in May 2017, with related proposals, and the Franco-German agreement reached at Meseberg in June 2018.

First, as regards the banking union^[111], a regulatory package was being finalised which includes directives and regulations that provide for a leverage ratio to prevent banks from excessively increasing leverage, a strengthening of risk-sensitive capital requirements for banks trading in securities and derivatives, and increased loss-absorbing recapitalisation capacity in global systemically important banks. Furthermore, an agreement was reached on new requirements as regards minimum loss coverage for new non-performing exposures on banks’ balance sheets. Moreover, the June and December Euro Summits decided to make the ESM the backstop to the Single Resolution Fund (SRF) for banks in resolution. As regards a European deposit insurance scheme (EDIS), European leaders consider further technical work as necessary, with a high-level working group having been set up that will report back in June 2019. Adhering to all elements of the 2016 roadmap in appropriate sequence, work started on a roadmap for beginning political negotiations on EDIS. Meanwhile, with the support of European banking supervision, euro area banks continued to strengthen their balance sheets, reduce their leverage and further bring down the stock of non-performing loans. Finally, progress on a European capital markets union (CMU) continued, in line with the 2015 CMU Action Plan.

Second, and in the light of ESM reform discussions, the ECB issued an opinion in which it endorsed bringing the ESM into the EU legal framework, improving its precautionary financial assistance instruments whilst ensuring adequate conditionality, and reviewing its governance to ensure swift and credible decision-making based on high-quality independent expert advice.

Third, technical work continued on the design of and timeframe for a fiscal stabilisation instrument, as well as other potential budgetary instruments for the euro area. In line with the Five Presidents Report of 2015, the ECB welcomed this work, highlighting that any fiscal instrument should support aggregate demand, in particular in euro area-wide recessions, whilst avoiding undermining incentives for sound national economic and fiscal policies. The ECB also issued an opinion on the proposal from the European Commission for a European Investment Stabilisation Function (EISF). The December Euro Summit mandated the Eurogroup to work on a budgetary instrument for convergence and competitiveness for the euro area and ERM II Member States on a voluntary basis, in the context of the Multiannual Financial Framework. Other deliberations in EU fora included a proposal by the Commission for a regulation on sovereign bond-backed securities (SBBS).

As regards structural economic issues, the European Commission proposed a Reform Support Programme to support the implementation of structural reforms as part of the next Multiannual Financial Framework (2021‑2027). The EU also agreed to increase the financial envelope of its already existing Structural Reform Support Programme to bring its total budget to €222.8 million over the period 2017‑2020.

As part of the debate on deepening EMU, the ECB frequently stressed that a full application of the budgetary rules and more effective coordination of economic policies remained vital to strengthen the resilience of the euro area and create the confidence among Member States needed to proceed towards further integration. In this respect, progress has been less than satisfactory.

10.2 Discharging accountability

The ECB’s accountability is the necessary counterpart to its independence. The ECB is an independent institution which has discretion to use its instruments as it deems necessary to carry out its tasks and fulfil its mandate. Such independence was democratically decided as part of the ratification of the Treaties, which also gave the ECB a clear mandate for which it is held accountable to the public. Accountability, complemented by judicial review by the Court of Justice of the European Union, ensures that independence does not lead to arbitrariness and that the ECB acts in accordance with its mandate.

The Treaties entrust the European Parliament – as the democratically elected representative body of EU citizens – with a central role in holding the ECB accountable. In 2018 the President of the ECB attended four regular hearings of the Committee on Economic and Monetary Affairs of the European Parliament.^[112] The President also attended the Parliament’s plenary debate on the ECB Annual Report and the ECB published its feedback on the input provided by the European Parliament as part of its resolution on the ECB Annual Report for 2016.^[113] The ECB also discharges its accountability obligations through regular reporting and by answering written questions from Members of the European Parliament (MEPs). In 2018 the President of the ECB received 36 letters containing such questions, the replies to which were published on the ECB’s website.^[114] Most of the questions raised by MEPs focused on the implementation of the ECB’s non-standard monetary policy measures, economic and financial conditions, and ECB and EU institutional issues. Finally, the ECB is also held accountable for its banking supervision activities by both the European Parliament and the EU Council.^[115]

The ECB engaged further in the debate which has emerged in recent years on central bank independence and accountability. In 2018 Executive Board members delivered several speeches on these issues^[116] and an article in the Economic Bulletin examined the evolution of the ECB’s accountability practices.^[117] Among other things, the article provided new quantitative and qualitative evidence on how the ECB’s interactions with the European Parliament had intensified and evolved during the crisis in terms of frequency, format and content.

According to the Eurobarometer survey^[118] in 2018, the euro’s popularity reached an all-time high, with 75% of the euro area’s 340 million citizens supporting the single currency. This is the highest level of support recorded in the survey since the euro’s introduction.

10.3 Implications of Brexit

While not party to the negotiations, the ECB has continued to monitor and assess Brexit-related developments under its mandate. The November 2018 ECB Financial Stability Review (FSR) examined the potential financial stability implications of Brexit for the euro area. Analysis concluded that Brexit poses limited overall risk to euro area financial stability, largely due to the range of options available to the private sector to mitigate potential risks. Transition to a new post-Brexit equilibrium will imply one-off adjustment costs and may entail risks of frictions in some market segments if the transition is not adequately prepared for. However, the risk that the euro area real economy would be deprived of access to financial services following the UK’s departure from the EU appears limited. Similarly, the analysis indicates overall limited risks to the capital position of the euro area banking sector. However, a cliff-edge Brexit could lead to a more broad-based and severe market repricing than that seen in 2018 and could lead to an abrupt increase in risk premia and volatility.

In April 2018 the ECB and the Bank of England set up a joint technical working group, whose mandate focuses on risk management in the period around 30 March 2019 in the area of financial services. The group updated the European Commission and the UK Treasury on its findings in October 2018.

At his February 2018 hearing before the European Parliament, the President of the ECB stressed the importance of making progress on key pieces of EU financial legislation – such as EMIR II – well in advance of Brexit, in order to be prepared for all possible contingencies, including a no-deal scenario.

In the area of European banking supervision, the ECB and national supervisors have focused on the communication and implementation of supervisory expectations concerning Brexit-related issues, as well as the assessment of the Brexit plans and licensing applications of international banks that are relocating activities from the United Kingdom to the euro area and the Brexit plans of euro area banks with material activities in the United Kingdom. Further information can be found in the 2018 ECB Annual Report on supervisory activities.

A withdrawal agreement had not been concluded by the cut-off date of this report.

10.4 International relations

G20

In an environment of continued economic growth, but with increased downside risks to the global outlook, G20 finance ministers and central bank governors discussed the implications of trade tensions for the global economy in 2018, stressing the need to step up dialogue and actions to mitigate risks. G20 members also reviewed the implications of tighter global financial conditions, in particular for emerging market economies. The G20 continued its monitoring efforts aimed at achieving strong, sustainable, inclusive and balanced growth globally and reviewed progress towards the collective growth ambition of 2% by 2018. The measures implemented in this context have prepared the global economy for growth above 2%, albeit to be achieved later than originally anticipated. Finance ministers and central bank governors renewed their commitment to stable exchange rates and the implementation of financial sector reforms. Under Argentina’s G20 Presidency, facilitating infrastructure financing and the future of work were among the priorities. The G20 also continued its efforts in the area of international taxation issues and considered the benefits and potential risks related to technological innovations, such as crypto-assets. The G20 reaffirmed its commitment to further strengthening the global financial safety net, with a strong, quota-based and adequately resourced IMF at its centre, and the global financial architecture. In this context, the G20 Eminent Persons Group on Global Financial Governance published its report “Making the Global Financial System Work for All”.

Policy issues related to the IMF and the international financial architecture

The ECB continued to play an active role in discussions about the international monetary and financial system at the IMF and in other fora, promoting a common European position from a central bank perspective.^[119] The IMF discussed or initiated important reviews of its policies under the surveillance and lending framework. In February 2018 the IMF introduced important clarifications of its policies related to programme design in currency unions. An interim review of IMF surveillance was concluded in April 2018 and the IMF Independent Evaluation Office issued recommendations on IMF financial surveillance in December 2018. The IMF also initiated a review of conditionality and the design of Fund-supported programmes, as well as a review of the debt sustainability framework for market-access countries. In addition, work on the 15th review of IMF quotas continued in 2018.

In July 2018 the IMF concluded its first euro area Financial Sector Assessment Program (FSAP) – a comprehensive exercise involving several European institutions, including both the central banking and supervisory arms of the ECB. The IMF stressed that banking supervision in the euro area had improved significantly since the creation of the SSM. In addition, while the resilience of large euro area banks has increased, there remain some vulnerabilities related to credit and market risk. The exercise will also inform and facilitate FSAP exercises at euro area country level. The IMF’s consultation on euro area policies, which was also concluded in July 2018, noted that the euro area expansion remains robust, albeit slowing to a more moderate pace. Moreover, building up sufficient policy buffers and implementing structural reforms remain of paramount importance in some member countries. In October 2018, at the Annual Meetings in Bali, the IMF launched the Bali Fintech Agenda, which discusses the opportunities and risks entailed by fintech developments and focuses on the implications of such developments for the financial sector.

International central bank cooperation

While considering its limited resources, the ECB continued to respond positively to strong interest from central banks outside the EU in the exchange of experience, reflecting its important role in the global economy and as a European institution.

The ECB widened the geographical reach of its cooperation by concluding a Memorandum of Understanding (MoU) with the South African Reserve Bank. In addition, relations with key central banks in Asia and Latin America were further developed based on existing bilateral MoUs. The ECB also strengthened its cooperation with regional organisations to broaden its outreach. Discussions at Eurosystem level also continued through a meeting of senior Eurosystem representatives and their Latin American counterparts.

The ECB continues to play its role as an EU institution through targeted discussions with central banks in countries that have the perspective of joining the EU. A regional workshop series serves as the main platform, and discussions are organised in close collaboration with EU NCBs where possible. The ECB also contributes to targeted cooperation activities led by EU NCBs to the benefit of such third-country central banks.

11 Enhancing communication

Over the past years central bank communication has increasingly become a core element of monetary policy, even becoming a policy tool in itself. By clearly signalling its intentions and communicating policies, especially to the financial markets and expert audiences, the ECB has successfully enhanced the effectiveness of its policies. In the past year the ECB further strengthened its efforts to reach out beyond its traditional audiences. The aim is to engage with wider civil society and have a conversation with and listen to the broader public, using new platforms and formats. Unlike communication with markets and experts, this type of engagement often deals with underlying questions about what the ECB does, why it does it, and how it is relevant to individual people and their communities. By reaching out to a wider audience and engaging in a genuine two-way dialogue, the ECB is seeking to enhance understanding of its role and policies and also to build trust in the ECB as an institution.

Focus on young people

Reaching out to young people in Europe is of particular importance to the ECB. To this end, the ECB launched its “Back to School” programme which encourages ECB staff to visit schools, in particular their own former schools, and join in conversations with students about Europe and the euro, responding to their concerns and sharing some personal insights into what it means to work in an EU institution. In 2018, 77 members of staff took up the initiative, demonstrating the enthusiasm of ECB staff to make the case for the euro, to help bring the EU closer to its citizens and to give something back to their communities.

In addition, the ECB expanded its “Youth Dialogues” in 2018. These are innovative platforms that allow students and young professionals to enter into genuine dialogue with senior ECB decision-makers. In January, for example, the ECB partnered up with Debating Europe for a youth dialogue with ECB President Mario Draghi. Using the hashtag #AskDraghi, young Europeans were invited to submit questions directly to the ECB, focusing on a range of topics, such as youth unemployment and crypto-currencies. Over 280 questions were received from all around Europe. The top five questions were answered by President Draghi in an interview published on the ECB’s website which also received wide media attention.

Many aspects of central bank policy are complex and often difficult for non-experts to understand. However, the ECB is determined to improve the accessibility and appeal of its communications, and has taken novel and innovative steps to this end. One example was an effort to enhance the reach of the ECB Forum on Central Banking in Sintra and make the important and insightful discussions there interesting and accessible to young people. The ECB invited the YouTuber and recent PhD graduate Simon Clark to cover the young economists’ session via his social media channels. Through exclusive behind-the-scenes shots and candid interviews with the economists, he provided a fresh perspective on the central banking forum, making its content more understandable and relatable to young people. The YouTube video has already been viewed more than 30,000 times.

The digital space is central to the ECB’s efforts to be present where people – especially young people – get their news and information. In November 2018 the ECB launched its official Instagram account which, relying predominantly on visuals, seeks to present the human side of the ECB by introducing staff members and sharing experiences of every day working life at the ECB. The concept behind the Instagram account is also educational, spreading visually attractive content through social media platforms. Furthermore, over 457,000 followers stay in touch with the ECB via its Twitter channel. Beyond that, the ECB has further expanded its online offer, and the ECB’s websites now have over 160,000 pages, many of which in 23 languages. A special hub, #EUROat20, commemorating the 20th anniversary of the single currency online was also created in a joint effort with other EU institutions.

As part of the ECB’s efforts to reach out beyond the experts and join in conversations about how ECB policy affects local communities and businesses across the euro area, Executive Board member Benoît Cœuré visited rural France in October where he met politicians, factory workers and students to explain the ECB’s recent monetary policy decisions, listen to people’s concerns and respond to criticism.

Finally, the ECB’s Visitor Centre, in its first full year of operation, welcomed 20,743 visitors. The Visitor Centre, located in the ECB’s main building in Frankfurt, enables citizens to explore the ECB’s tasks, history and mission, as well as enter into a conversation with an ECB representative.

12 Good governance, organisational excellence, resilience and environmental performance

Strengthening its reputation as a world-class institution and inspiring, developing and engaging its people are two of the ECB’s strategic priorities. In 2018 these priorities guided the ECB in its efforts to: (i) create organisational excellence through a more diverse and inclusive culture and enhanced integrity, transparency and accountability to EU citizens; (ii) build up resilience in the face of technological threats through an enhanced capacity to defend the ECB and the financial ecosystem from cyberattacks; and (iii) ensure a strong environmental performance through a continuous reduction of the ECB’s ecological footprint.

12.1 Unlocking excellence through diversity and inclusion

The ECB believes that diversity and inclusion can unlock excellence: diverse teams contain a broader range of viewpoints, leading to better decision-making and more robust results. Fostering diverse teams and inclusive behaviour is vital to ensure the ECB can deliver the best possible outcomes for its staff and for the EU. That is why diversity, respect, an ethical culture and the well-being of its staff are strategic objectives for the ECB.

In 2018 the ECB continued its efforts to foster diversity and inclusion as key drivers of improved organisational performance. At the core of these efforts are respect, fairness, inclusiveness and equal opportunities for staff, regardless of, among other things, gender, nationality, religion, sexual orientation, ethnic origin, age, cultural background or disability. The ECB has a number of diversity networks that engage frequently with Human Resources and aim to serve the needs of all aspects of diversity. At the ESCB/SSM level, the ECB has exchanges with NCBs and NCAs regarding best practices in diversity and inclusion, an example of which was the third annual meeting of the ESCB/SSM Diversity Network in Rome in October 2018.

In 2018 the ECB’s comprehensive programme of activities included raising the rainbow flag on the International Day Against Homophobia, Transphobia and Biphobia (IDAHOT), running “inclusive leadership” workshops for ECB managers, celebrating the International Day for the Elimination of Racial Discrimination, and organising dedicated speaker events on LGBT+ and gender equality topics.

The ECB is continuing to work towards increasing the number of women in management positions. To achieve a greater gender balance, the ECB’s Executive Board set targets for the end of 2019 and complemented them with a broad set of measures to ensure they are reached. These measures include a dedicated “women in leadership” training programme, extensive opportunities for flexible working arrangements, a focus on inclusive leadership among managers, and diversity ambassadors working in each business area to improve the local gender balance.

At the end of 2018, 29% of management positions were held by women, compared with a target of 35% for the end of 2019. For senior management roles, the share was 22%, against a 2019 target of 28% (see Table 2). The overall share of female staff at the ECB at all levels is 44%.

In view of the ongoing challenges, in 2018 the ECB’s Executive Board adopted additional measures to improve gender diversity. It was decided that, in each business area, at least one member of the senior management team and at least one-third of the wider management team should be female. In addition, ECB recruitment procedures have been adjusted to attract more female applicants. This includes, for example, greater involvement of recruitment agencies tasked to search for potential female candidates. Furthermore, if any recruitment procedure does not attract a satisfactory number of female applicants, it can be stopped and relaunched. In addition, more women across the ECB will participate in recruitment panels in order to counter potential bias and to ensure more gender-balanced decision-making.

12.2 Strengthening integrity and governance standards

The ECB, with the support of its Ethics Committee and Audit Committee, strives for the highest level of integrity and governance standards.

On the advice of the Audit Committee, the Governing Council asked the Ethics Committee to draw up a Single Code of Conduct for high-level ECB officials. The new Code introduces a comprehensive, state-of-the-art ethics framework for members of the Governing Council, Executive Board and Supervisory Board. Moreover, it expressly extends the Guiding principles for interactions with external parties to members of the Governing Council and Supervisory Board. Members of the General Council and other high-level ECB bodies, such as the Audit Committee, the Ethics Committee and the Administrative Board of Review, commit themselves to abide by the main general principles. The Single Code reflects the ECB’s core principles and values, while appropriately taking into account the ECB’s specificities as a central bank, banking supervisor and EU institution. It furthermore responds to suggestions made by ECB stakeholders with regard to integrity standards, accountability and transparency.

With regard to members of staff, following a recommendation by the ECB’s external auditor, the annual compliance check of private financial transactions, which covers a randomly selected group of staff members, was complemented by an ad hoc compliance check, which focuses either on a specific group of staff members or on specific types of transactions.

In the course of 2018 the ECB’s Audit Committee assessed key aspects of corporate governance at the ECB, covering both the central banking and banking supervision arms, and in the Eurosystem. The Audit Committee focused in particular on the proper functioning of the Eurosystem’s financial risk management framework, progress made towards coordinated action plans addressing cyber risks, and organisational initiatives to increase the effective operation of the SSM.

As part of its commitment to openness and transparency, the ECB decided to establish a Public Register of Documents. This register will be gradually enhanced and complemented to provide the general public and markets with user-friendly access to documents on the ECB’s policies, activities and decisions in a structured and easily retrievable manner.

12.3 Cyber resilience

Information sharing is necessary for the proper functioning of the financial ecosystem, including central banks and the ECB itself. Hence, it is of primary importance to protect the integrity and confidentiality of data and ensure the availability of IT systems. The growing interconnectedness and complexity of the IT landscape and the increasing amount of data on digital platforms and across networks have been accompanied by increased exposure to cyberattacks and potential cyber incidents.^[120] Cyberattacks on financial entities and their service providers are a serious concern, as they have a negative impact on consumers and businesses and could lead to systemic risks, affect financial stability and even impair economic growth.

The ECB has enhanced its own defence capabilities by developing governance frameworks and strengthening security controls via technology (including design, development and operation), processes, training and testing. Moreover, in collaboration with the financial ecosystem partners, the ECB promotes system-wide resilience. Cyber resilience is the ability to anticipate and adapt to cyber threats and other relevant changes in the environment and to withstand, contain and rapidly recover from a cyber incident.

The ECB has developed a governance framework for digital security and cyber resilience which describes the governance and organisational arrangements for the ECB’s own digital security and cyber resilience, including a clarification of roles and responsibilities. Cyber risks are operational risks and therefore come under the umbrella of the overall operational risk management framework. The digital security and cyber resilience framework complements the frameworks governing the ECB’s approach to non-financial risk management and increases the understanding and awareness of digital security, cyber risk and cyber resilience. The ECB’s response and recovery capabilities in the event of a cyberattack on its own organisation will be further strengthened in 2019 by enhancing business continuity plans and testing the existing incident and crisis management arrangements.

Security involves collecting and analysing threat intelligence and implementing defensive measures, as well as augmenting detection and response capabilities. Incident reporting, collaboration and information sharing are vital for effective protection. Within the ECB, the new Cyber Security Steering Committee (CSSC) facilitates information exchange, policy alignment and working-level cooperation in order to foster the cyber resilience of the ECB and the European financial sector. The ECB promotes information sharing within the ESCB and facilitates the Operational Security Situational Awareness (OSSA) network for information exchange, which has 33 member institutions worldwide.

Owing to the continuous evolution of cyberattacks, there is a need to keep individuals continuously updated about new security threats and possible countermeasures. It is crucial for the ECB to establish high levels of awareness among members of staff about IT security in order to ensure that both users and information assets are protected. Staff members are given training to enhance their IT security skills and competence. Mandatory online training will be launched in 2019. Behavioural testing and testing of IT systems and processes are performed regularly.

The ECB focuses on cyber resilience from a regulatory perspective as part of its operational risk considerations for financial market infrastructures (FMIs), striving to ensure the implementation of relevant standards within the euro area and promoting harmonisation at international level. In line with this approach, the Eurosystem has established a cyber resilience strategy for FMIs with a series of measures addressing the resilience of individual FMIs, sector resilience and strategic regulator-industry engagement.

In order to ensure that the CPMI‑IOSCO “Guidance on cyber resilience for financial market infrastructures” is followed consistently, the Eurosystem has developed “Cyber resilience oversight expectations for financial market infrastructures” (CROE). The CROE serve three key purposes:

• they provide FMIs with detailed steps on how to operationalise the guidance, ensuring that they are able to foster improvements and enhance their cyber resilience over a sustained period of time;
• they provide overseers with clear expectations to assess FMIs under their responsibility;
• they provide the basis for a meaningful discussion between the FMIs and their respective overseers.

In May 2018 the ECB launched the European framework for Threat Intelligence-based Ethical Red Teaming (TIBER‑EU), which was developed by the Eurosystem as a tool to enable FMI operators to enhance their cyber resilience. TIBER‑EU is the first common European framework facilitating a controlled, bespoke, intelligence-led red team test of critical live production systems, based on the tactics, techniques and procedures of real-life attackers. Its aims are to ensure standardisation and mutual recognition of cyber testing across the EU and to avoid that FMIs have to undergo separate tests in each EU Member State.

As part of efforts to enhance the operational resilience of the financial sector, the Eurosystem, under its oversight mandate, arranges market-wide crisis communication exercises. In 2018 the Eurosystem organised the UNITAS table-top crisis communication exercise. The participants, including major euro area payment systems, central securities depositories, central counterparties, service providers, market infrastructures and central bank overseers, were presented with the scenario of a cyberattack on FMIs which compromised their data integrity. The exercise took the form of a facilitated discussion among market participants, allowing them to make observations and reach conclusions based on the scenario and to identify possible areas for collective work to further enhance the cyber resilience of the wider sector.

Recognising the need for a forum to bring together market actors, competent authorities and cybersecurity practitioners at a pan-European level, the Eurosystem set up the Euro Cyber Resilience Board for pan-European Financial Infrastructures (ECRB). The ECRB’s objective is to enhance the cyber resilience of FMIs and their critical service providers, as well as of the wider EU financial sector, in line with international standards. This will be achieved by fostering trust and collaboration and facilitating joint initiatives – whether among market players or between market players and authorities.

The ECB includes cyber resilience and operational resilience in its supervision of banks’ IT risks. Cyber risk deserves special consideration given banks’ increased interconnectedness and greater dependence on IT and the speed at which vulnerabilities can be found and exploited by determined attackers.

In 2018 the ECB implemented the EBA Guidelines on ICT (Information and Communication Technologies) Risk Assessment under the SREP (EBA/GL/2017/05), leading to a consistent and comprehensive assessment of the IT risk situation in all supervised significant credit institutions in the euro area, which resulted in both specific follow-up activities at individual banks and thematic findings to be addressed on a broader scale. More generally, the ECB has emphasised that banks need to continue to be alert to all kinds of IT risk and should not limit their activities to only selected IT risk areas.

The ECB has contributed significantly to the EBA Guidelines on ICT and security risk management, which were published for consultation in December 2018. These are expected to harmonise IT risk management requirements for banks across Europe and foster a more level playing field. In addition, the supervision of IT risks at the ECB continues to include ongoing supervision by Joint Supervisory Teams, intrusive and targeted on-site inspections focused on specific IT risk objectives, and staying informed of cyberattacks through the ECB’s cyber incident reporting framework.

Active collaboration across the globe, and in particular at European level, to reinforce the cyber resilience of the financial ecosystem continues.

12.4 Reducing the ECB’s ecological footprint

As a European institution, the ECB is conscious of its responsibility to contribute to environmental protection and address the challenges posed by climate change for the well-being of society and future generations. Since the adoption of its first environmental policy in 2007 the ECB has worked continuously on improving its environmental performance and reducing its carbon footprint. The ECB has been registered with the European Eco-Management and Audit Scheme (EMAS) since 2010 and its environmental management system covers all three buildings in which ECB staff are located in Frankfurt – the main building in Sonnemannstrasse, the Japan Center and the Eurotower.

Environmental protection is an integral part of the ECB’s business strategy and shapes its daily operations and processes. With the support of over 50 internal environmental representatives and many committed teams and individuals across the organisation, the ECB strives for a continual reduction in its ecological footprint. The ECB is demonstrating its commitment by raising staff awareness, implementing efficiency measures and engaging with various stakeholders to work together on achieving the ECB’s environmental objectives. One such measure was the launch of a versatile online collaboration tool that enables the ECB to interact with its counterparts remotely. This tool not only enriches online interactions, but also allows travel to be avoided whenever possible, thereby reducing emissions. In addition, the ECB has further optimised the lighting profile of its main building to reduce the lighting intensity in certain areas and has adjusted operating schedules to make further energy savings. Furthermore, disposable cups in the common areas have been replaced with reusable ones, considerably reducing waste.

2018 was an eventful year for the ECB in terms of environmental awareness-raising activities, as the ECB participated in several international campaigns. The ECB joined the Frankfurt community in its call to action to shine a light on climate change during the WWF’s Earth Hour 2018. Together with 183 other businesses and institutions in Frankfurt, the ECB switched off all non-essential lights and staff were encouraged to join the campaign and identify further ways to be more environmentally friendly. Another initiative was the ECB’s participation for the sixth time in the European Mobility Week. In order to encourage ECB staff to make greener choices for their daily commute to and from work, various activities such as bike safety checks, team competitions and mobility and climate quizzes were organised. In addition, staff were provided with information on environmentally friendly mobility at the ECB.

Support from external providers is also crucial to reducing the ECB’s environmental impact. Sustainability criteria were taken into account, for instance, when selecting the ECB’s cleaning contractor. These criteria led to the introduction of many environmentally friendly materials in daily operations, such as recycled paper in washrooms. The cleaning company providing services to the ECB uses innovative, non-hazardous, fully biodegradable cleaning products and mechanical deep-cleaning procedures only. The dosing process has also been optimised to reduce water consumption and improve water recycling when cleaning floors.

In order to have more impact and to continue learning from each other, the ECB works closely with NCBs and with other European institutions and bodies. Together they can share best practices, discuss and explore new solutions to common challenges and communicate jointly about their environmental performance. On the common webpage EMAS in the European Institutions, the European institutions and bodies explore the practical benefits of being EMAS-registered and share best practices and resource savings. Thus, interinstitutional collaboration forms another crucial pillar of the ECB’s commitment to environmental protection.

The ECB also publishes information on its environmental performance and the measures it has implemented on the webpage Environmental protection at the ECB.

Annual Accounts

https://www.ecb.europa.eu/pub/pdf/annrep/ecb.annualaccounts2018~cd3eabaa40.en.pdf

Consolidated balance sheet of the Eurosystem as at 31 December 2018

https://www.ecb.europa.eu/pub/pdf/other/ecb.eurosystembalancesheet2018~5b51d1aefe.en.pdf

Statistical section

https://www.ecb.europa.eu/pub/pdf/annrep/ecb.ar_annex2018_statistical_section~7ddac28291.en.pdf