Riding out the Storm

Mr Stark, we're in the ECB tower and things feel pretty calm here. But have you felt the shockwaves that have swept financial markets?

Juergen Stark: Of course. Here in Europe, we're feeling the shockwaves primarily caused by problems in the US. It's been going on for months now and recently we've had a new shockwave that we've had to respond to. But we've acted decisively with other central banks to inject fresh liquidity into markets.

Did the crisis surprise you?

I think we need to make a distinction here. Over the past few years there have been excesses and market corrections were necessary. And only when those corrections have started can we ask how this whole process will develop.

Here at the European Central Bank we warned about the risks which in our opinion were not properly assessed by market players. And in an environment where low interest rates and low inflation prevailed, banks were naturally inclined to seek higher returns. There was a race for high returns and in that race the banks took high risks. And those risks are now materializing.

Do you think US regulators were asleep at the helm?

I wouldn't like to pin the blame solely on US authorities. I think there are many here in Europe who contributed to the situation, primarily in the risk management departments of banks.

So does risk management need to be improved?

I think there's consensus among banks and among regulators that it is an important element that needs to be improved.

What can the ECB do to calm markets?

First of all, we need to work to ensure that the nervousness and -- in parts -- panic doesn't spill over into central banks. And I think we here at the ECB are equipped with a clear mandate and a clear monetary strategy to overcome the problems.

What we've done since August of last year -- and we're in the 13th month of this process -- is put more liquidity at banks' disposal. The inter-bank lending market -- that is where banks lend among themselves -- had seized up.

So you threw money at the market?

To solve the liquidity problem, we temporarily made funds available to banks backed by collateral. It will not be an ongoing phenomenon -- so there is no danger of it sparking off inflationary pressure.

On one day alone you made 70 billion euros available. Did that have the effect you had predicted?

It's true that we did make an additional 70 billion euros available to banks - but only for 24 hours and only if the borrowing was backed by collateral.

But as we saw in August and September last year, trust among banks towards each other has been greatly eroded. They don't know how many potential risks are lying in the books of other banks. So institutions have begun to hoard liquid funds - and not pass them on to other banks.

But that doesn't help...

But it does. Because we help banks who otherwise wouldn't have access to liquidity on the normal market, to get hold of it.

People in Europe have the feeling that consumers here are having to pay for the sins of Americans, due to the domino effect of the crisis. What do you think of that?

First of all, there is no domino effect. What we're seeing in this latest phase of turbulence on capital markets are structural re-adjustments. It's normal in an economy for market players who can no longer stick it out, to leave the game.

But some of those players are solid banks who are now at risk.

Of course yes, I was talking about the past. We're living in uncertain times and nobody knows what will happen in the next days and weeks. We're feeling the shockwaves and ripples, but there's no need to be worried in Europe.

It's a process that was sparked off in the US and has now reached the shores of Britain. But I can say that the German banking system -- the euro-zone banking system -- entered this process with strong profitability and capitalization.

But can you understand why people in Europe are worried? They are phoning banks and asking if their money is safe.

It's understandable on a psychological level...but once again, there's no reason to worry.

How closely is the ECB working with the US Federal Reserve in this crisis?

We are in continuous contact in the usual bilateral bodies but we're also looking more closely at what's happening in the US right now. What we did this week was work in closer cooperation with other central banks and act as an agent of the Fed to inject more dollar liquidity into the market which had seized up.

American banks hoarded dollar reserves with the effect that foreign banks could not access them. Dollars became scarce. So we and other central banks reached an agreement with the Fed so that we would act as agents of the Fed and put dollars on the market. And I think it's a sign of the level of trust that among central banks during this critical period.

So the US needs Europe to cope with this crisis?

It's in the interest of our banks to be able to do business in dollars and that is the basis of our cooperation.

Are we at the end of the crisis?

What we are experiencing here are the after-shocks of the credit crunch that rocked America. It's been 13 months since it started and total losses and write-downs amount to some 500 billion dollars so far. And I don't know what is yet to come. The whole financial sector is going through a clean-out and it will last some time. No one is in a position to predict an end to all this.

Manuela Kasper-Claridge interviewed Juergen Stark (sp)