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Interview by Christina Hiptmayr published?on November 18, 2023 in the Austrian magazine "profil" and online on November 20th, 2023, original in German: Bankexperte Dombret: ?Noch nie war die Regulierung so streng“ (profil.at)

"Never before has bank regulation been so stringent"?

Andreas Dombret, banking expert, former board member of Deutsche Bundesbank and now global senior advisor at Oliver Wyman , talks about vulnerabilities in the financial system, the ?beast“ of inflation, and the controversial topic of the digital euro.

Profil: The world seems to be full of crises: The war against Ukraine, the Israel-Gaza conflict, high inflation, recession, and the climate crisis. From a macroeconomic perspective, what concerns you the most amidst all of this?

Dombret: It won't surprise you that as former central banker I mention inflation first. It is still too high, and I am not sure the target of 2 percent inflation can be achieved in the Eurozone by 2025 as planned.

Profil: Why is that?

Dombret: This is due to the many geopolitical risks that naturally cause a lot of concern. Their impact is quite substantial. Globalization, as we have experienced it for a long time, will not continue as long as the West and the Global South hold such different positions. At the International Monetary Fund 's autumn meeting in Marrakesh, representatives of the Global South unofficially esplained to me repeatedly that the West has the wrong priorities and that reducing poverty should be a higher focus than combating climate change.

Profil: Both the European Central Bank (ECB) and the Federal Reserve Board (Fed) have allowed for 10 percent inflation. Is this a failure of central banks?

Dombret: We have seen a point where inflation has gotten out of hand. However, you can only compare the Fed and the ECB to a limited extent because in Europe, we faced a supply side shock in the food and energy markets due to the Ukraine war - something the US did not experience. A central bank cannot be pleased at all when inflation deviates so far from its target, but I believe that the central banking community has reacted very consistently and reasonably to the situation. So, it's less a question of whether it was a failure but rather if the reaction was appropriate. I believe it was appropriate.

Profil: But was it not too slow?

Dombret: In hindsight we all know better. I do believe it was somewhat late. But if inflation is mainly attributable to energy and food prices due to the Ukraine war, higher interest rates can only reduce inflation to a limited extent.

????????????: Some economists believe that allowing a higher inflation rate of 4 or 5 percent for a while is acceptable. Do you agree?

Dombret: I find it problematic to change horses in the middle of the race. This would undermine confidence in the European Central Bank if it realizes that achieving the 2 percent target is becoming more difficult and suddenly changes direction.

Profil: Do you fear a second inflation wave, similar to what was seen in the 1970s, because the Fed eased its interest rate policy too early?

Dombret: The two situations cannot be easily compared. But when it comes to interest rate moves, it's generally better to do a bit too much than too little. Despite all the effects this has on the economy, since mid-last year, there have been 10 consecutive interest rate moves in the eurozone, totaling 450 basis points, which have had a tremendous impact. However, the effects only manifest themselves with a time lag, making an exact landing impossible. Unfortunately, the inflation beast is not yet defeated, but this is imperative. We will likely have to prepare for an extended period of higher interest rates, which could last well into much of next year.

Profil: Assuming the ECB can't get inflation under control, would that endanger the currency union?

Dombret: I don't think so. I have no doubt that the European Central Bank and the national central banks will do everything in their power to get the present inflation under control.

Profil: In Europe, there is often criticism that banks are overly regulated. In Austria, for example, guidelines for granting real estate loans have been tightened. Are banks being too tightly controlled?

Dombret: Bank regulation has never been as strict as it is today. But let's not forget that the global financial crisis 15 years ago caused significant turmoil. Our financial system was on the brink. Back then, we assumed that the real economy and the financial economy are distinctly separated from each other, and we had to learn painfully that they are not separate systems. At that time, there was almost no transparency for bank supervisors on where the risks lay. There was also no mechanism for the resolution of banks - bank insolvency was not envisioned. Regulators then closely examined the most dangerous, complex and risky significant bank groups and developed new regulations for these institutions. When the cases of Silicon Valley Bank and 瑞信 occurred earlier this year, all the banks that had criticized strict regulation in the past were quick to point out how strong their equity and liquidity buffers were. However, they wouldn't have built them up to such an extent without strict regulation. So it is clear that our banking system has become significantly safer due to regulation after the global financial crisis.

Profil: Where do you see vulnerabilities?

Dombret: I'm concerned that a lot of bank business is migrating to shadow banks. I'm talking about credit funds, where many loans are granted outside the banking sector. There's a lack of transparency, and in the end, we might have to pay for it because similar problems may arise as they did with Lehman. We need a regulatory level playing field.

Profil: We've talked a lot about the ECB's 2 percent target. Another goal is the digital euro. In the banking world, it's not met with unanimous enthusiasm. Can you understand that?

Dombret: Yes, I understand it well. But I am very surprised that the criticism and interventions against the digital euro are coming so late in the process. It has been clear from the beginning that the digital euro will affect the deposit situation of banks and savings banks.

Profil: In what way?

Dombret: Currently, it's being discussed that each customer can hold up to 3000 euros in the digital euro. This means that banks lose the interest rate differential between the deposit and loan interest rates in this amount, and their financing through deposits is also reduced. Now, the banking associations have woken up and criticize this very loudly in some cases.

Profil: How can the project be made attractive to banks?

Dombret: I believe the digital euro must be seen in a more fundamental way. It's about whether there should be digital currencies only from private or also from public providers. For central banks, the question arises: Do you create your currency only through cash and the creation of money through lending via banks? Or do you also offer something in the digital realm - not least to defend the sovereignty of your own currency? There is, of course, an interest in ensuring that the euro, with 20 percent of the world's currency reserves, remains or even expands its value in the world. Where I find criticism justified is that banks and savings banks have been involved very little by the central banking community so far. It only makes sense to introduce something like a digital currency if it is actively used. I don't think most citizens currently understand the advantages and disadvantages associated with a digital euro, and this is a prerequisite for its success.

Profil: Honestly, I don't understand this either. I have my banking app on my phone and can make transfers quickly and easily. Why do I need the digital euro?

Dombret: It is particularly of interest in times of crisis. With the digital euro, you have a guaranteed claim from the ECB that you can always enforce. If the digital euro is also, as planned by the ECB, free and usable online and offline at any time, then it has significant advantages for consumers and is an interesting additional option.

Profil: Is the?project a precursor to the abolition of cash?

Dombret: Certainly not. My positive attitude towards the digital euro would immediately turn negative if it meant the abolition of cash. Every citizen should decide for him- or herself which form of payment they want to choose, whether it's cash, a credit card, bitcoins, or the digital euro.

Profil: Many worry that a surveillance system is being established here.

Dombret: I don't want to downplay that; you are addressing an important point. But I am sure that the ECB will manage consumer data exceptionally well. Many private providers use consumer data to their advantage. Banks also have a lot of data about you and know your consumer behavior precisely. In a time when many people are transitioning from cash to digital forms of payment, it is my prediction that the digital euro will interest more people than you think. However, other forms of payment will continue to exist.