UPDATE 1-ECB will link up with bank watchdog to monitor stability risks

Mon Jun 23, 2014 10:53am EDT

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FRANKFURT, June 23 (Reuters) - The European Central Bank will start to hold regular meetings with the European Union's new bank supervisor to keep a closer eye on risks to financial stability, ECB Vice President Vitor Constancio said on Monday.

Historically low interest rates and unconventional monetary polices to support economic recoveries with "too low rates of inflation" are causing some markets to overheat, Constancio warned. Among them is real estate, whose boom in the early 2000s helped set the stage for the financial crisis.

"Right now, the low nominal growth requires low interest rates, and this creates the possibility of activating 'the risk-taking channel' and search for yield, and restrictive macro-prudential measures become necessary," Constancio said in a speech at an ECB research conference.

Coordinating the two functions of monetary policy and macro-prudential policy would help control future risks. Consequently, the ECB Governing Council and the Supervisor Board of the Single Supervisory Mechanism (SSM) will hold regular joint meetings.

"It is a decision by the Governing Council to have these at least quarterly meetings with the Supervisory Board of the SSM to discuss macro-prudential issues," Constancio told reporters on the sidelines of the conference.

PREVENTION BETTER THAN CURE

Constancio emphasised that in matters of financial instability, prevention is always better than cure.

"The crisis showed that the amount of risk endogenously generated by a financial cycle spinning out of control dwarfs the 'mopping up' ability of fiscal and monetary policy, due to fiscal capacity limits and the zero lower bound on nominal interest rates," he said.

The global economy is slowly emerging from the financial crisis after massive interventions by major central banks, which cut interest rates close to zero. In the case of the United States, Japan and Britain, they also flooded the market with liquidity by buying large amounts of assets.

This has driven up prices for some assets, such as property , as investors search for higher returns and are increasingly willing to take on more risk.

The issue has grabbed the attention of international organisations. The International Monetary Fund urged Britain earlier this month to cool its housing market by reining in risky mortgages, and in its financial stability report in May, the ECB warned about growing imbalances.

"The ECB's and the IMF's financial stability analyses confirm that specific asset segments, among which (are) real estate, point to some overheating in some countries," Constancio said. "The issue then arises as to whether macro-prudential policy needs to react."

In the last quarter, he said, Belgium, the Netherlands, Slovenia and Estonia had activated macro-prudential policies - capital-related measures aimed at managing systemic risk in the financial system.

(Reporting by Eva Taylor; Editing by Larry King)

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