Munich, Germany, June 29, 2012 — MMG members met today and agreed at the conclusion of their meeting to release the statement below. The purpose of the MMG is to consider and identify potential systemic risks and alert market participants and policymakers to these risks. The MMG is co-chaired by Jacques de Larosière, Chairman of Eurofi, former Managing Director of the International Monetary Fund and former Governor of the Banque de France, and by David A. Dodge, Senior Advisor of Bennett Jones, LLP and former Governor of the Bank of Canada.

Most MMG members broadly agreed that:

1. Addressing the persistent and destructive negative feedback loop between the troubles of Euro Area sovereigns and the broader banking community is a matter of the highest priority. In this connection, the statement of the Euro Area Summit earlier today is welcome. The signal of intention to establish a single supervisory mechanism creating the possibility of recapitalizing banks directly is encouraging. Likewise, the indication that EFSF/ESM funds for Spain’s banking sector would not have seniority over private claims reflects an important recognition that such seniority would undermine the objective—breaking the negative feedback loop and restoring confidence in Euro Area sovereign debt markets. Nevertheless, such statements require concrete and immediate steps to give confidence to all parties that these directions will be fully realized.
2. On the medium term issues, recent proposals have set out a possible roadmap to more fiscal and financial sector integration; these include more effective oversight of national budgets, plans for more mutualization of sovereign debt and direct support for troubled banks. For financial sector integration, the necessary steps include common bank supervision, common bank recapitalization funds and some form of region-wide deposit insurance. These proposals could represent meaningful progress toward stabilizing market sentiment if there is prompt follow-through.
3. Time is short. Despite determined reform efforts and an agreement to recapitalize its savings banks, Spain’s sovereign funding costs have risen by over two full percentage points since the end of February, to levels which may not be sustainable. The upward pressure on Italian government bond yields is another clear signal of growing risk. Facing effectively closed funding markets and regulatory pressures to raise capital, many Euro Area banks continue to retrench both from domestic credit provision and cross-border lending. Urgent additional action is needed both to alleviate short-term market strains and to define a more fundamental medium-term framework for the future of the Euro Area.
4. For fiscal and banking sector integration to work, it is imperative to address the Euro Area’s “growth deficit.” Without laying the foundation for more robust growth, ongoing fiscal consolidation—coupled with expected further deleveraging—could see the growth deficit worsen, eroding political support for the whole integration effort. This will require concerted efforts to advance structural reforms in key areas in order to enhance sustained growth and productivity.
5. MMG members noted growing threats to the global economy from a number of sources, including concerns about potential threats to growth in the U.S. and China as well as disruption caused by the Euro Area sovereign debt crisis. Against this backdrop, instead of individual moves, coordinated global macroeconomic policies involving both developed and emerging market countries—could improve market sentiment and provide essential support.
6. Participants highlighted concerns that U.S. fiscal tightening set to take place in early 2013 could significantly affect U.S. growth in the very near term. While most expect that measures will be agreed to ward off a U.S. “fiscal cliff,” political uncertainty on the outcome and timing of these steps constitutes a distinct event risk. This should be clarified as soon as possible. Participants also highlighted the continued need for a clear commitment to achieve fiscal consolidation in the medium term.
7. Participants emphasized the systemic risks associated with divergent national banking system regulations that inhibit the efficient use of liquidity and capital on a cross-border basis.
8. In this context, the MMG also underscored that regulatory changes, coupled with increased counterparty risk and volatility of underlying assets, have led to a greater desire to hold high quality collateral, increasing the “price of safety” above any estimates that traditional analysis of long-term fundamentals would support. As safe assets are hoarded, collateral shortages increase, reducing the potential for secured borrowing and thus curtailing the remaining credit channel to the financial system and the broader economy. In addition, members underscored the importance of a prompt modification of the proposed liquidity coverage ratio guidelines.
9. The increase in the “price of safety,” i.e. the decline in bond yields of perceived safe-havens such as Treasuries and Bunds, also reflects the continued environment of “low for long” rates. Among the risks associated with this environment are the search for yield, which encourages relaxation of credit standards and contributes to potential asset price bubbles. Sustained low rates also create difficulties for long-term providers of contractual savings (pension funds and life insurers), putting them under pressure to reduce supply and return on their products: individuals will thus retire with lower accumulated assets and uncertain provision for their retirement—a potential burden on already fiscally challenged governments.
10. Two other areas of potential systemic risk which MMG members believe could warrant additional attention include the impact of regulatory reforms which discourage long-term investors from allocating funds to equities and other long-term investments—and also encourage the convergence of asset allocation strategies of traditionally heterogeneous investors. They also stressed the growing lack of liquidity in corporate bond markets, driven in part by more stringent capital requirements for trading books.