Foreword

2016 was in many ways a difficult year, but it was also marked by signs of progress. Though the year began shrouded in economic uncertainty, it ended with the economy on its firmest footing since the crisis.

Yet as economic uncertainty subsided, political uncertainty increased. We faced a series of geopolitical events that will shape our policy landscape for years to come. This year’s Annual Report describes how the ECB navigated these choppy waters.

2016 opened amid fears of a renewed global slowdown, reflected in pronounced financial market volatility. There was a danger that the return of inflation to our objective would be further delayed and – with inflation already very low – deflation risks were material. Just as in 2015, the Governing Council remained determined to use all the tools within its mandate to fulfil its objective.

So in March, we introduced a series of new measures to expand our monetary stimulus, including lowering our key policy rates further, increasing the asset purchase programme from €60 billion to €80 billion a month, purchasing corporate bonds for the first time, and launching new targeted longer-term refinancing operations.

As we describe in the Report, these measures proved very effective in easing financing conditions, sustaining the recovery and – eventually – supporting a gradual adjustment of inflation rates towards levels closer to our objective.

With our policy working, in December the asset purchase programme was extended by nine months to ensure longer support to financing conditions and a sustained return of inflation towards, but below, 2%. The volume of purchases was, however, reset to its original level of €60 billion per month. This reflected the success of our actions earlier in the year: growing confidence in the euro area economy and disappearing deflation risks.

Yet alongside these benefits, monetary policy has side-effects – it always does. In 2016 those side-effects were frequently in the spotlight. In this year’s Report we address some of the questions and concerns about the unintended consequences of our actions.

One is about their distributional effects, especially in terms of inequality. We show that, over the medium term, monetary policy has positive distributional effects by reducing unemployment, which benefits poorer households the most. After all, bringing people into a job is one of the most powerful drivers of lower inequality.

Another concern is about the profitability of banks, insurers and pension funds. We discuss how financial institutions have been affected by, and responded to, the low interest rate environment. We show that the ability of banks to adapt depends on their specific business models.

The Report covers other challenges for the financial sector in 2016. We look in particular at the problem of non-performing loans, what needs to be done to tackle it, and the obstacles which remain. We also have a special feature on new technology and innovation in the sector, how it might affect the structure and functioning of the sector, and what this means for overseers and regulators.

And no review of 2016 could be complete without considering the seismic political changes of the year, not least the decision of the United Kingdom to exit the European Union. Accordingly, the Report assesses Brexit from an ECB perspective. Above all, we emphasise the importance of preserving the integrity of the Single Market and the homogeneity of its rules and their enforcement.

Political uncertainty is likely to persist into 2017. But we remain confident that the economic recovery, buoyed by our monetary policy, will continue. The ECB has a clear mandate for its actions: to maintain price stability. This guided us successfully through 2016 – and it will continue to do so in the year to come.

Frankfurt am Main, April 2017

Mario Draghi

President

The euro area economy, the ECB’s monetary policy and the European financial sector in 2016

The euro area economy

The global macroeconomic environment

In 2016 the euro area economy faced a demanding external environment. Growth in both advanced and emerging market economies was modest by historical standards and there were episodes of heightened uncertainty and short-lived peaks in financial market volatility, particularly following the UK referendum on EU membership in June and the US presidential election in November. Global inflation was subdued owing to the gradually diminishing impact of past oil price declines and still abundant global spare capacity.

Global economic growth remained modest

The world economy continued to recover gradually in 2016, although at a slightly lower rate than in the previous year as a result of the deceleration in advanced economies. Economic activity only gathered pace in the second half of the year, particularly in emerging market economies. Overall, global GDP growth remained below its pre-crisis rates (see Chart 1).

2016 was marked by some significant political events, which clouded global economic prospects. In June 2016 the outcome of the UK referendum created uncertainty about the UK’s economic outlook, yet the immediate financial and economic impact proved short-lived and modest. Later in the year, the outcome of the US election brought a shift in expectations about the future policies of the incoming US administration, which led to another bout of heightened policy uncertainty.

Advanced economies continued to grow, albeit at a lower rate than in the year before. Still accommodative financing conditions and improving labour markets supported economic activity. Growth in emerging market economies was also moderate for the year as a whole, with prospects improving significantly in the second half. Two factors were of particular influence: the continuing gradual deceleration of the Chinese economy, and the progressive easing of the deep recessions in major commodity-exporting economies. That said, growth remained restrained because of geopolitical tensions, excessive leverage, vulnerability to capital flow reversals and, in the case of commodity exporters, slow adjustment to lower revenues.

Global trade growth was weak in 2016, with the volume of world imports expanding by only 1.7% annually, following growth of 2.1% in the previous year. There is evidence that certain structural developments that boosted trade in the past – such as falling transportation costs, trade liberalisation, expanding global value chains and financial deepening – will not support trade to the same extent over the medium term. Accordingly, world trade is not very likely to grow faster than global economic activity in the foreseeable future.

Global financing conditions remained favourable throughout the year. Central banks in major advanced economies maintained an accommodative policy stance, with the Bank of England, the Bank of Japan and the ECB continuing their expansionary monetary policies. The US Federal Reserve System resumed its monetary policy normalisation by raising the federal funds target range by 25 basis points in December 2016. Financial markets showed overall resilience, in spite of spells of heightened uncertainty triggered by political events. Towards the year-end, US long-term bond yields increased markedly. It is still unclear whether this increase reflects higher growth and inflation expectations or rather a spike in term premia on US long-term bonds. Most emerging markets benefited from an improvement in external financing conditions until the US election in November. Thereafter, however, the earlier increase in capital flows towards emerging market economies started to unwind, with government bond spreads rising and pressures on currencies intensifying in a number of countries.

Abundant spare capacity continued to weigh on global inflation

During 2016 global inflation continued to be influenced by low oil prices and still abundant global spare capacity (see Chart 2). Annual headline inflation in the OECD area rose gradually towards the end of the year and reached 1.1% for the year as a whole, compared with 0.6% in 2015. Core annual OECD inflation (excluding food and energy) increased slightly to 1.8% (see Chart 1).

Oil prices recovered from a low of USD 33 per barrel at the end of January 2016 to USD 55 per barrel at the end of December. The curtailment of investment by US oil companies and a sudden increase in the number of global oil supply disruptions during the first half of the year drove prices higher.^[1] Towards the end of the year oil prices were significantly affected by OPEC’s supply strategy. Following the decision on 30 November to enforce, in the first half of 2017, a cut among OPEC members (by 1.2 million barrels per day), the price of Brent crude oil increased. The upward move was also supported by an agreement between OPEC and some non-OPEC producers on a further cut in production (by 0.6 million barrels per day) on 10 December.

In 2016 non-oil commodity prices recovered; however, quotations showed opposite dynamics in the food and metal sectors. The price of agricultural commodities increased owing to weather-related issues in the first part of the year and retreated over the summer on account of abundant wheat and grain harvests. Metal prices remained at low levels in the first part of the year, as China announced environmental policies restraining the consumption of metals. As the future demand outlook improved in connection with potential new infrastructure investment in China and the United States, metal prices then partially recovered.

Overall, slowly closing output gaps in advanced economies, the modest decline in the ample spare capacity in several emerging market economies and the waning effects of past falls in oil and other commodity prices put slight upward pressure on global inflation in the second half of 2016.

Growth continued across the major economies

In the United States, economic activity slowed in 2016. Following a modest expansion in the first half of the year, real GDP growth rebounded in the second half. Growth was mainly driven by consumer spending, employment gains and strengthened household balance sheets. The drag from an inventory adjustment and declining energy investment that suppressed growth in the first half of the year diminished towards the end of the year, contributing to stronger activity. Overall, GDP growth declined from 2.6% in 2015 to 1.6% in 2016. The underlying labour market momentum remained robust, with a further decrease in the unemployment rate to 4.7% and a pick-up in wage growth at the end of the year. Inflation remained well below the target of the Federal Open Market Committee (FOMC). Overall, annual consumer price index inflation reached 2.1% in 2016, while core consumer price index inflation (excluding food and energy) increased to 2.2%.

Monetary policy remained highly accommodative in 2016. In December, in a move that was widely anticipated by financial markets, the FOMC decided to raise the federal funds target range by 25 basis points to 0.5-0.75%. The fiscal stance was slightly expansionary in the fiscal year 2016, with the fiscal deficit increasing slightly to 3.2% of GDP as a result of increased spending related to healthcare costs and higher net interest payments.

Japan saw solid growth in 2016, helped by accommodative monetary and fiscal policies, easier financial conditions and a tightening labour market. On average, real GDP growth decelerated slightly to 1% in 2016 from 1.2% in the previous year. The unemployment rate declined to 3.1%, but wage growth remained subdued. Annual headline consumer price inflation (CPI) turned negative in 2016, reaching -0.1%, mainly reflecting declining global commodity prices and the stronger yen. The Bank of Japan’s preferred measure of core inflation – CPI excluding fresh food and energy – declined somewhat compared with the previous year and stood at 0.6% in 2016. In September the Bank of Japan introduced quantitative and qualitative monetary easing with yield curve control. It also committed itself to expanding the monetary base until the observed rate of inflation exceeded its price stability target and remained above that level in a stable manner.

In the United Kingdom, the economy remained robust despite uncertainty related to the outcome of the referendum on the country’s EU membership. In 2016 real GDP increased by 2.0% according to preliminary estimates, mainly supported by robust private consumption.^[2] In financial markets, the most notable response to the referendum outcome was a sharp depreciation of the pound sterling. There was a pick-up in inflation from very low levels. Monetary policy remained accommodative during 2016. In August the Bank of England’s Monetary Policy Committee cut the main policy rate by 25 basis points to 0.25%, expanded its asset purchase programme and launched a Term Funding Scheme to support the interest rate pass-through to the economy. In November the government announced a new fiscal mandate and targeted policy measures, particularly in the areas of housing and infrastructure investment, to support the economy during the transition phase.

In China, growth stabilised in 2016, supported by strong consumption and infrastructure spending. Annual GDP growth stood at 6.7% in 2016, after 6.9% in the previous year. Manufacturing investment remained weak, but property investment picked up slightly. Import demand recovered from its low in 2015, but remained weaker than in the past. Relatively subdued foreign demand weighed on exports, which in turn negatively affected imports through processing trade. Annual consumer price inflation increased to 2%, while annual producer price inflation, which has been in negative territory since March 2012, rose to -1.4%.

The effective exchange rate of the euro remained broadly stable

In 2016 the exchange rate of the euro was broadly stable in nominal effective terms (see Chart 3). In bilateral terms, however, the euro moved against some of the other major currencies. Against the US dollar, the euro was remarkably stable during most of 2016 as yields on either side of the Atlantic remained largely unchanged, but declined towards the end of the year. A weakening of the euro against the Japanese yen was partially compensated for by an appreciation against the pound sterling.

The Danish krone is currently the only currency in the European exchange rate mechanism II (ERM II). The Danish krone traded close to its central rate within ERM II, while Danmarks Nationalbank increased its policy rate in January 2016 and, in net terms, purchased foreign currency with Danish kroner in 2016. Česká národní banka continued to purchase foreign currency in line with its commitment to intervene in foreign exchange markets in order to keep the exchange rate of the Czech koruna from appreciating beyond a certain level. Likewise, Hrvatska narodna banka continued to conduct interventions in foreign exchange markets under its managed floating exchange rate regime. The Bulgarian lev remained fixed to the euro. The euro also remained broadly stable vis-à-vis the Swiss franc as well as the Hungarian forint and the Romanian leu, while it appreciated against the Swedish krona and, to a lesser extent, the Polish zloty.

Financial developments

In 2016 the euro area financial markets continued to be driven, to a large extent, by further monetary policy accommodation implemented by the ECB. It contributed to a gradual decrease in euro area government bond yields in the first three quarters of the year. However, as a result of global factors, towards the end of the year euro area government bond yields recovered part of the decline recorded earlier in 2016. Money market rates and the cost of external financing for non-financial corporations continued to decline, reaching historical lows. Non-financial corporations and households experienced further improvements in their financing conditions.

Euro area money market rates declined

Money market rates continued to decrease in 2016, mainly on account of further monetary policy easing by the ECB.

The easing measures are explained in more detail in Section 2.1. The deposit facility rate cut was swiftly and completely passed through to the EONIA, which subsequently stabilised at around -35 basis points (see Chart 4). In line with its historical pattern, the EONIA increased temporarily at month-ends, but these increases were less pronounced than those in early 2015 before excess liquidity started to rise sharply with the implementation of the asset purchase programme (APP).

The three and six-month EURIBOR declined further into negative territory. The decrease in EURIBOR rates followed the further easing of monetary policy, with some additional downward pressure stemming from the upward trend in excess liquidity. The increase in excess liquidity by more than €500 billion throughout the year was primarily due to the purchases under the APP and, to a lesser extent, the new series of targeted longer-term refinancing operations (TLTRO-II). Excess liquidity reached €1,200 billion by the end of the year (see Chart 4).

In the secured money market, repurchase agreement (repo) rates also continued to decline, driven by the key ECB interest rate cuts, ample liquidity conditions and a search for high-quality collateral. Repo rates quoted for collateral issued by some euro area countries stood below the level of the deposit facility rate for most of the year, reflecting demand for highly liquid collateral.

Euro money market forward rates bottomed out after the UK referendum on EU membership at the end of June amid higher market expectations of further ECB monetary policy easing. However, by the end of the year, forward rates had reversed as market expectations of additional policy rate cuts declined and the EONIA forward curve steepened. The curve’s steepening in tandem with a rise in euro area sovereign bond yields mirrored developments in global longer-term yields, which were most pronounced in the United States.

Euro area government bond yields increased towards the end of the year

Euro area government bond yields were lower overall in 2016 than in 2015, reflecting the continued support from the ECB’s purchases of euro area government bonds and other monetary policy measures. Yields in both the euro area and the United States underwent a significant adjustment owing to global developments (see Chart 5). The increased uncertainty regarding global growth prospects at the beginning of the year resulted in a strong decline in risk-free interest rates. The outcome of the UK referendum compressed yields further before a more optimistic global outlook and the outcome of the US presidential election led to an increase in yields in both the euro area and the United States. Overall, the euro area GDP-weighted average of ten-year sovereign bond yields declined by around 30 basis points in 2016 and stood at around 0.9% at the end of the year. Developments in intra-euro area government bond spreads were relatively muted, but showed some heterogeneity across countries.

Euro area equity prices were broadly unchanged after temporary declines

2016 started with a significant decline in global equity markets as developments in China sparked global growth concerns (see Chart 6). As concerns receded, equity markets returned around April to the levels seen at the beginning of the year. A similar pattern was observed in the period around the UK referendum, when a sharp decline in the days after the referendum was reversed in the following months. In the second half of the year the euro area equity market increased markedly on account of an improved outlook. Despite the relatively large movements during the year, the euro area equity market remained broadly unchanged, with the broad EURO STOXX index increasing by around 1%. The small increase in the overall index masked a decline in bank equities, which were negatively affected by banks’ stock of non-performing loans and continued low profitability, among other things.

Equities in the United States showed a similar pattern over the course of the year, but performed more strongly overall and recorded an increase of close to 10% in 2016. In December 2016 the major equity indices in the United States reached a new all-time high.

Non-financial corporations benefited from a lower cost of external financing

The monetary policy measures taken in 2016 were also transmitted to the overall nominal cost of external financing for non-financial corporations (NFCs), which reached a historical low in the summer of 2016 (see Chart 7). In particular, negative deposit facility rates and the new TLTRO-II operations announced in March helped to further reduce the cost of bank lending for NFCs. The introduction of purchases of investment-grade euro-denominated bonds issued by non-bank corporations established in the euro area, along with the other elements of the APP, pushed the cost of market-based debt to levels significantly below those recorded in the previous year and also below bank lending rates. However, as the equity risk premium remained elevated, the cost of equity declined only marginally in 2016. The high level of monetary policy accommodation contributed to reducing the cost of external financing, as well as the heterogeneity of external funding costs across euro area countries and across firms of different sizes.

External financing flows stabilised in 2016

In the first three quarters of 2016 NFCs’ external financing flows stabilised close to the average level recorded in 2015 (see Chart 8). From a longer-term perspective, the recovery in NFCs’ external financing flows from the lows reached in the first quarter of 2014 is still supported by: (i) the further decline in financing costs; (ii) an easing of credit constraints; (iii) a continued expansion of economic activity; and (iv) stronger merger and acquisition activity. Moreover, the ECB’s accommodative monetary policy has also contributed to creating favourable conditions for NFCs’ access to market-based financing. In particular, the extension in June 2016 of the APP to include corporate bonds supported the issuance of debt securities in the year. Improved credit conditions^[3] and lower interest rates led to a slight increase in NFCs’ recourse to bank-based financing, while loans from non-MFIs and the rest of the world declined significantly over the year. Unquoted shares and other equity remained the largest component of NFCs’ external financing flows, supported by high retained earnings. The issuance of quoted shares was restrained by the relatively high cost of equity. Moreover, the general improvement in access to external financing by NFCs dampened trade credit and inter-company lending dynamics.

Growth in the net wealth of households accelerated

In the first three quarters of 2016 the net wealth of households continued to grow at an increasing pace (see Chart 9). In particular, continuous house price increases resulted in significant capital gains on households’ real estate asset holdings. The increase in share prices in 2016 led to gains on the value of households’ financial asset holdings and made a positive contribution to growth in net wealth.

The cost of borrowing for euro area households reached a record low, but continued to vary across countries and loan maturities, with the cost of long-term loans declining by more than the cost of short-term loans. Bank borrowing by the household sector continued to recover in 2016.

A broad-based recovery

The domestic demand-led economic recovery in the euro area that started at the beginning of 2013 continued in 2016. Looking at the factors driving economic activity, the current growth momentum appears to be becoming more resilient (see Box 2 for more details). At the same time, euro area economic activity has been held back by the still subdued growth in foreign demand amid heightened global uncertainty. As a result, average annual growth stood at 1.7% in 2016 (see Chart 10). This is only slightly lower than the 2.0% recorded in 2015, which was boosted by particularly strong GDP growth in Ireland. Private consumption increased at a rate similar to that in 2015, again fuelled by rising disposable income, while investment rose at a slightly slower pace than in the previous year, notwithstanding the recovery in the construction sector. At the same time, government consumption rose at a stronger rate in 2016, thus contributing positively to economic growth (see Section 1.6 of Chapter 1). The economic recovery was relatively broad-based across euro area countries.

The euro area economy continued to expand

The very accommodative monetary policy stance of the ECB continued to be transmitted to the real economy and supported domestic demand. Improvements in corporate profitability and very favourable financing conditions further promoted a recovery in investment. Moreover, sustained employment gains, which also benefited from past structural reforms, continued to support the recovery. The still relatively low level of oil prices provided further impetus to growth in 2016. Meanwhile, public and private sector indebtedness, which remained at high levels in some countries, and the associated deleveraging needs dampened domestic demand. Moreover, slow progress in implementing structural reforms continued to be a drag on growth.

Euro area private consumption strengthened further in 2016, with an average annual growth rate of around 2.0%, which was broadly similar to that in the previous year. The main factors driving the increase in private consumption were the low oil price, particularly at the beginning of the year, and improvements in euro area labour markets and the resulting increase in labour income. In this respect, it was mainly the growth in the number of jobs, rather than higher wages, which contributed to total nominal labour income growth in 2016. Low interest rates continued to support private consumption as borrowing became cheaper and saving less rewarding. In addition, although the net interest income of euro area households decreased marginally in 2016, lower interest rates mainly redistributed resources from net savers to net borrowers, who typically have a higher propensity to consume than net savers.^[9]

The monetary policy measures implemented by the ECB over recent years, including the corporate sector purchase programme announced in March 2016, have spurred demand and hence promoted investment. As a result, investment continued to contribute substantially to growth in 2016, also reflecting improvements in firms’ profits, less constrained demand and increasing capacity utilisation. Moreover, the monetary policy measures have boosted business confidence, reduced firms’ net interest payments and eased financial conditions, including those for small and medium-sized enterprises, thereby further strengthening business investment. Investment in transport equipment contributed to the recovery in business investment in particular. Nevertheless, some factors may have weighed on firms’ investment activities, such as the prolonged decline in euro area long-term growth expectations, ongoing corporate balance sheet adjustments related to firms’ high indebtedness and weaker global trade.

Construction investment also improved, albeit from low levels, alongside the recovery in euro area housing markets. The latter reflected higher demand, which was in turn supported by real income growth, and favourable mortgage rates and lending conditions on the back of monetary policy measures, as well as fiscal incentives in some countries. Furthermore, returns on alternative forms of household investment remained low, providing further incentives for residential investment. The recovery of the housing market was widespread across euro area countries.

Economic growth dynamics continued to be dampened by the weak external environment in 2016, which more than offset the impact of the lagged effects from the sizeable depreciation of the euro in 2014-15 (see Section 1.1 of Chapter 1). Euro area exports to the United States, Asia (excluding China) and emerging market economies remained subdued in 2016. At the same time, trading partners in Europe and China withstood these headwinds and increasingly contributed to euro area exports. Trade within the euro area strengthened in 2016 and mirrored the underlying momentum in domestic demand.

From a sectoral perspective, the rise in output in 2016 was broad-based (see Chart 11). Total gross value added, which in the second quarter of 2015 surpassed its pre-crisis peak in the first quarter of 2008, rose by around 1.7% on average in 2016. Value added growth in industry (excluding construction) slowed down to around 1.6% in 2016, while the services sector expanded by 1.8%, which was somewhat higher than in 2015. At the same time, value added in construction, albeit still far below its pre-crisis level, gained momentum, rising by around 2.0% – the highest growth rate recorded since 2006. This confirms that developments in the construction sector are becoming increasingly positive following the protracted period of contraction or slow growth that started in 2008.

Euro area employment continued to rise

Labour markets recovered further in 2016 (see Chart 12). By the third quarter of 2016 the number of persons employed in the euro area stood 1.2% above the level at the same time in 2015, or more than 3% above the last trough in the second quarter of 2013. However, employment stood around 0.5% below its pre-crisis peak in the first quarter of 2008. Looking at the sectoral breakdown, employment increased mainly in the services sector and, to a lesser extent, in industry excluding construction, while employment in construction remained broadly stable.

In the first three quarters of 2016 total hours worked rose at a similar pace to headcount employment. Annual productivity growth per person employed remained low, averaging around 0.4% per quarter over the first three quarters of 2016, compared with an annual rise of 1.0% in 2015 (which was, however, boosted by the GDP revision in Ireland).

The unemployment rate continued to decline in 2016 and stood at 9.6% in December, which was the lowest rate since mid-2009. The decline in unemployment, which started in the second half of 2013, has been broad-based across gender and age groups. For 2016 as a whole, the unemployment rate averaged 10.0%, compared with 10.9% in 2015 and 11.6% in 2014. However, broader measures of labour market slack remained elevated.

Price and cost developments

In 2016 the pattern of headline inflation in the euro area, as measured by the Harmonised Index of Consumer Prices (HICP), mainly reflected the influence of energy prices. This influence accounted for the low or even negative rates in the early months of 2016, but also for the subsequent upward trend as the negative contributions of energy waned. Underlying inflation, as measured by HICP inflation excluding energy and food, did not show any sign of an upward trend, hovering between 0.7% and 1.0% during the year.

Headline inflation was driven largely by energy prices

In 2016 headline HICP inflation in the euro area was 0.2% on average, up from 0.0% in 2015. The profile of HICP inflation was mostly determined by energy price developments (see Chart 13). Headline inflation was negative in spring, but thereafter increased gradually. By December it had increased by more than 1 1/4 percentage points compared with the low in April.

By contrast, various alternative measures of underlying inflation did not show any clear signs of an upward trend (see Chart 14). HICP inflation excluding energy and food hovered between 0.7% and 1% throughout 2016. The lack of any upward momentum in underlying inflation was partly due to the indirect downward effects of past sharp declines in oil prices and other commodity prices, which materialise with a lag. More fundamentally, domestic cost pressures – in particular those stemming from wage growth – also remained subdued (for more details, see Box 3).

Looking at the main components of the HICP in more detail, energy inflation made a negative contribution to headline inflation of -0.5 percentage point on average in 2016. This was mainly due to developments in oil prices in euro terms, which primarily affect consumer liquid fuel prices. They also feed through to consumer gas prices, but the pass-through is less direct and weaker and has a longer lag.^[14]

Food price inflation fell back to 1.0% on average in 2016, after trending upwards in 2015 to 1.4% in the fourth quarter of 2015. This decline as well as fluctuations in the course of the year were mainly attributable to developments in unprocessed food prices, in particular fruit and vegetable prices, reflecting mainly transitional effects such as sharp weather-related increases in July and August and the subsequent strong downward correction in September and October. Processed food inflation, by contrast, remained broadly stable throughout the year.

The annual rate of change in non-energy industrial goods prices increased to 0.7% in January and February, but then decreased and stood at 0.3% from August to December. This decrease was driven by the prices of durables and semi-durables, the two components of non-energy industrial goods with the highest import content, which are thus more likely to be affected by the appreciation of the nominal effective exchange rate of the euro that started in spring 2015. Non-durable goods inflation remained broadly stable.

In this respect, pipeline pressures remained weak in 2016. The annual rate of change in import prices declined markedly in 2015 and has been negative since early 2016, mainly reflecting the direct impact of the appreciation of the nominal effective exchange rate of the euro (see Chart 15). On the domestic side, producer price inflation in the non-food consumer goods industries hovered at levels around zero throughout the year. Developments in producer prices in the intermediate goods industries point to a notable impact of crude oil and other commodity prices at the earlier stages of the price chain and a subsequent influence also on the later stages (as measured in consumer goods prices).

Services price inflation hovered around 1.1% throughout 2016, substantially below its longer-term average. Items in the services component of the HICP tend to be produced domestically, which means that services prices should be more closely linked to developments in domestic demand and labour costs. The subdued developments are thus likely to reflect the still sizeable slack in the euro area product and labour markets.

Domestic cost pressures remained subdued

Domestic cost pressures stemming from labour costs remained subdued in the first three quarters of 2016.

Growth in compensation per employee and unit labour costs in the euro area stood on average at 1.3% and 0.9% respectively in the first three quarters of 2016 (see Chart 16). The slight recovery in unit labour costs in 2016 compared with 2015 mainly reflected a reduction in labour productivity growth, while growth in compensation per employee remained low. Factors explaining the subdued wage pressures include the still large amount of labour market slack, structural reforms in labour markets in recent years that have resulted in higher downward wage flexibility in some euro area countries and low inflation.^[15]

Domestic cost pressures stemming from profit developments (measured in terms of the gross operating surplus) decreased somewhat in 2016 compared with 2015. This could indicate that the upward effects on profits of terms-of-trade improvements related to weak oil prices, which had been the dominant factor pushing up profits in 2015, were fading as oil prices continued to recover from the lows reached in early 2016.^[16] As a result, profits per unit of output were the main driver of the slight decrease in the annual rate of change in the GDP deflator from the fourth quarter of 2015 to the third quarter of 2016.

Long-term inflation expectations stabilised

Survey-based long-term inflation expectations stabilised in 2016. The Survey of Professional Forecasters showed five-year-ahead inflation expectations at 1.8% in all four rounds in 2016. The level of longer-term inflation expectations in the October 2016 Consensus Economics survey was slightly higher at 1.9%. After reaching historical lows in July, the inflation expectations implied by five-year inflation-linked swap rates five years ahead recovered. However, market-based long-term inflation expectations remained lower than survey-based expectations throughout the year.

Money and credit developments

Low interest rates and the effects of the ECB’s monetary policy measures continued to support money and credit dynamics. Money growth stabilised in 2016 at a robust level, while the gradual recovery in credit growth continued.

Money growth remained broadly stable

In 2016 broad money growth remained broadly stable, although M3 dynamics weakened somewhat in the second half of 2016 (see Chart 17). In December 2016 annual M3 growth stood at 5.0%, compared with 4.7% at the end of 2015. 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. The ECB’s non-standard measures, especially its asset purchase programme (APP), were additional important drivers of monetary developments in the euro area. Growth in M1, which benefited from the elevated growth of overnight deposits held by both households and non-financial corporations (NFCs), was strong, but moderated from its peak in mid-2015. It stood at 8.8% in December 2016, compared with 10.7% in December 2015.

As regards the other main components of M3, the low remuneration of less liquid monetary assets contributed to the ongoing contraction of short-term deposits other than overnight deposits (i.e. M2 minus M1), which remained a drag on M3 growth. The growth rate of marketable instruments (i.e. M3 minus M2), which have a small weight in M3, recovered somewhat, supported by solid growth in money market fund shares/units and increased holdings of banks’ short-term debt securities.

Money creation was again driven by domestic sources

Domestic counterparts other than credit to general government exerted a positive impact on M3 growth during 2016 (see the blue bars in Chart 18). On the one hand, this reflected the gradual recovery in the growth of credit to the private sector. On the other hand, the significantly negative annual rate of change in MFIs’ longer-term financial liabilities (excluding capital and reserves) continued to support M3 growth. This development was in part explained by the relatively flat yield curve, linked to the ECB’s monetary policy measures, which has made it less favourable for investors to hold long-term deposits and bank bonds. The attractiveness of the targeted longer-term refinancing operations (TLTROs) as an alternative to longer-term market-based bank funding also played a role.

Purchases of debt securities in the context of the public sector purchase programme (PSPP) had a considerable positive impact on M3 growth (see the red bars in Chart 18). By contrast, the contribution of credit to general government from monetary financial institutions excluding the Eurosystem was negative (see the green bars in Chart 18). Meanwhile, the net external asset position of euro area MFIs (which is the mirror image of the net external liability position of euro area non-MFIs settled via banks) remained the main drag on annual M3 growth (see the yellow bars in Chart 18). This development notably reflected ongoing capital outflows from the euro area and portfolio rebalancing in favour of non-euro area investment instruments. PSPP-related sales of euro area government bonds by non-residents made an important contribution to this trend, as their proceeds were invested mainly in non-euro area instruments.

Credit growth continued to recover at a moderate pace

The gradual recovery of credit growth reflected developments in loans to the private sector (see Chart 17). The annual growth rate of MFI credit to euro area residents (including the general government and the private sector) increased throughout 2016, to stand at 4.7% in December, up from 2.3% in December 2015. An improvement in dynamics was noticeable in particular for loans to NFCs. Growth in loans to NFCs has recovered substantially from the trough of the first quarter of 2014. This development was facilitated by significant declines in bank lending rates supported by a further reduction in bank funding costs, which was notably driven by the ECB’s non-standard monetary policy measures. However, the consolidation of bank balance sheets and still high levels of non-performing loans in some countries continue to curb loan growth.

Moreover, as indicated by the January 2017 euro area bank lending survey, changes in loan demand across all categories supported a recovery in loan growth, while credit standards for loans to enterprises are broadly stabilising. This survey identified the low general level of interest rates, merger and acquisition activities, corporate restructuring and housing market prospects as important drivers of increasing loan demand. In this context, the APP had a net easing impact on credit standards and particularly on credit terms and conditions. Banks also reported that the additional liquidity from the APP and the TLTROs was used to grant loans, as well as to replace funding from other sources. They also indicated that the ECB’s negative deposit facility rate had a positive impact on lending volumes, while contributing to a narrowing of loan margins.

Bank lending rates charged to households and non-financial corporations declined to historical lows

The ECB’s accommodative monetary policy stance, a strengthened balance sheet situation and receding fragmentation in financial markets in general have supported a decrease in banks’ composite funding costs, which reached historical lows. Since June 2014 banks have been passing on the decline in their funding costs in the form of lower lending rates (see Chart 19), which also declined to all-time lows. Between the beginning of June 2014 (the start of the ECB’s credit easing) and December 2016, composite bank lending rates for NFCs and households decreased by around 110 basis points. In addition, bank lending rates for both NFCs and households continued to show reduced dispersion across countries.

Fiscal policy and structural reforms

The euro area fiscal deficit continued to decline in 2016, mainly driven by lower interest payments and a favourable cyclical position, while the euro area fiscal stance was expansionary. The euro area public debt ratio continued to fall. However, in a number of countries the debt level remains high, which calls for further fiscal efforts and a more growth-friendly fiscal policy to set public debt ratios firmly on a downward path. Stepping up the implementation of reforms in the business and regulatory environment would help increase the euro area’s growth potential. In addition, to boost employment, comprehensive labour market reforms are needed.

Fiscal deficits declined further in 2016

Based on the December 2016 Eurosystem staff macroeconomic projections, the euro area general government fiscal deficit declined from 2.1% of GDP in 2015 to 1.8% of GDP in 2016 (see Chart 20). This is broadly similar to the European Commission’s winter 2017 economic forecast. The reduced deficit was a result of lower interest payments and a favourable cyclical position, which more than offset the worsening of the cyclically adjusted primary balance. The improvement in the aggregate euro area fiscal deficit reflected improved fiscal positions in most euro area countries.

The euro area fiscal stance, which is measured by the change in the cyclically adjusted primary balance net of the budgetary impact from government assistance to the financial sector, was expansionary in 2016 (see Chart 20).^[20] This was mostly the result of discretionary fiscal measures on the revenue side, such as cuts in direct taxes in a number of euro area countries. It was also supported by relatively dynamic growth in social payments and intermediate consumption. There is evidence that a number of countries may have used part of the interest savings to increase primary spending rather than to reduce their public debt levels or to build up buffers. The inflow of refugees had a smaller impact on public finances than in the previous year.

The euro area public debt ratio continued to fall

The euro area government debt-to-GDP ratio continued to decline gradually from its peak in 2014. Based on the December 2016 Eurosystem staff macroeconomic projections, the debt-to-GDP ratio fell from 90.4% in 2015 to 89.4% in 2016. The improvement in 2016 was supported in roughly equal measure by three factors: (i) favourable developments in the interest rate-growth differential, in the light of low interest rates and an economic recovery; (ii) small primary surpluses; and (iii) negative deficit-debt adjustments (see Chart 21).

In a few countries, however, public debt levels are still high and even increasing. This is all the more worrying as a high government debt burden makes the economy more vulnerable to macroeconomic shocks and financial market instability and limits the room for fiscal policy to act as a shock absorber.^[21] Thus, countries with high debt-to-GDP ratios in particular should set their public debt ratios firmly on a downward path, in full compliance with the Stability and Growth Pact (SGP). Containing risks to debt sustainability is also crucial from a longer-term perspective, in view of substantial challenges from population ageing reflected in rising pension, healthcare and long-term care costs. The 2016 healthcare report by the European Commission identified key reform needs in the EU countries to contain spending pressures in the area of health and long-term care.^[22]

Available fiscal space varied across countries

While further fiscal consolidation efforts are indispensable for several euro area countries to ensure fiscal sustainability, other countries have fiscal space to use, while fully complying with the SGP. The SGP allows for some flexibility, which is potentially conducive to addressing stabilisation needs at the national level. For example, the SGP offers some leeway with regard to public investment and the costs of structural reforms.

The size of the fiscal space and its use varied across euro area countries. Some countries, such as Germany, made use of available fiscal space, for instance to accommodate the sizeable budgetary impact of the refugee influx. By contrast, countries without fiscal space were required to implement fiscal measures to ensure compliance with the SGP requirements. Some countries, such as Italy, Latvia and Lithuania, also benefited from room for higher deficits granted by the SGP flexibility provision on public investment, pension reforms and structural reforms.

To make the best use of available fiscal space, countries should direct their policy action towards well-tailored public investment spending, which can be expected to make a lasting contribution to economic growth in the medium term. Although the size of the macroeconomic effects is uncertain, public investment can be expected to have positive demand effects and raise potential output by increasing the stock of public capital.^[23]

Moreover, to support economic stabilisation, countries should also strive for a more growth-friendly composition of fiscal policies. On the expenditure side, spending reviews are a promising way to identify entitlements that do not necessarily result in welfare increases and would help to ensure a more efficient use of public money. On the revenue side, improving the growth-friendliness of the tax system and limiting tax evasion are important reform areas in a number of countries. In particular, reducing the labour tax wedge, i.e. the tax burden on labour income resulting from personal income tax and social security contributions, can have positive growth and employment effects.^[24]

Mixed record of compliance with EU fiscal rules

Countries need to ensure strict compliance with the provisions of the SGP and a timely correction of debt sustainability risks. In 2016 euro area countries’ compliance with the SGP was rather mixed, while on the implementation side a more forceful application of the fiscal rules would have been welcome to ensure that the SGP remains fully credible.

Fiscal consolidation is progressing, which also helped several countries to exit their excessive deficit procedures (EDPs). In 2016 EDPs were closed in a timely manner for Ireland and Slovenia, as well as for Cyprus, which was even one year ahead of its EDP deadline. Among the euro area countries, only France, Spain and Portugal remained under the corrective arm of the SGP in early 2017.^[25]

Nevertheless, for a number of euro area countries the European Commission identified large consolidation gaps with respect to the SGP requirements in 2016 and thereafter, but this did not result in any material stepping-up of the respective procedures in the SGP.^[26] For example, in relation to the country-specific recommendations published in May 2016, the Commission examined the breach of the debt criterion in Belgium, Italy and Finland in 2015. However, based on the assessment of the numerical debt benchmark and/or the relevant factors as outlined in the SGP, it decided against opening an EDP. Moreover, despite the failure of Spain and Portugal to take effective action, the Council followed in August 2016 the Commission recommendation not to impose fines. Instead, Spain was granted a two-year extension of the EDP deadline to 2018, together with a significant reduction of the required adjustment. For Portugal, which suffered from the fiscal costs of financial sector support in 2015, the EDP deadline was extended by one year to 2016. In addition, there was no proposal by the Commission to suspend parts of the European structural and investment funds.

The European Commission published its assessment of the 2017 draft budgetary plans on 16 November 2016. It found that six countries under the preventive arm, namely Belgium, Italy, Cyprus, Lithuania, Slovenia and Finland, were at risk of non-compliance with the SGP requirements.^[27] Among the countries under the corrective arm, France and – after having submitted an updated draft budgetary plan – also Spain were assessed to be broadly compliant with the provisions of the SGP. For Portugal, the threshold for a significant deviation was expected to be exceeded, although only by a very narrow margin. The Eurogroup stated on 5 December 2016 that Member States remaining in the corrective arm of the SGP should ensure a timely correction of their excessive deficit, appropriate convergence towards the medium-term objective thereafter, and respect of the debt rule.^[28]

Better institutions are key to higher potential growth

Although the economic recovery is proceeding, structural medium-to-long-run challenges for euro area growth remain. Weak productivity growth, high levels of debt and structural unemployment hinder stronger economic growth and call for a renewed impetus from supply-side policies. There is ample evidence that weak trend GDP and employment growth is associated with a lower quality of national institutions (such as the control of corruption and the rule of law), as well as rigid labour and product market structures.^[29] Indeed, sound institutions and economic structures are essential for the resilience and long-term prosperity of the euro area (see Chart 22).^[30]

A number of indicators suggest that the reform momentum in the euro area faded significantly after 2013 and reform implementation rates have fallen back to pre-crisis levels.^[31] This slowdown in reforms is regrettable, since there are already examples of credible and well-targeted reforms implemented during the crisis that have resulted in substantial benefits for the euro area countries in question.^[32]

Sluggish implementation of reforms raises concerns about euro area growth and employment prospects, and holds back further necessary improvements in the shock-absorption capacity of Monetary Union. Table 1 shows the progress achieved in the implementation of the European Commission’s 2016 country-specific recommendations (CSRs). Clearly, reform implementation has been rather limited across euro area countries. For example, none of the recommendations was fully addressed, while for only two of them substantial progress was registered. However, some progress could be seen in the majority of euro area countries in 2016 regarding reforms of framework conditions (e.g. improving the efficiency of insolvency frameworks, enhancing private sector debt restructuring and increasing small and medium-sized enterprises’ access to finance). Regarding fiscal-structural reforms, action continued to focus on reducing the tax wedge on labour, while some euro area countries also tried to enhance the efficiency of public administration and tax collection. With regard to reforms in the labour market or measures to increase competition in the services sector, progress has been much more limited, or even absent, in most euro area countries. Where there have been reforms, they have typically been carried out in a piecemeal manner. This has meant that potentially important complementarities between different reform areas have been neglected and opportunities have been missed to fully internalise demand-stimulating effects which emerge from raising expectations of higher future incomes.^[33]

Overall, governments should step up the implementation of business-friendly reforms. As shown above, some efforts to improve the business and regulatory environment were made in 2016, but the progress in recent years has been far too limited to align the euro area countries with global best practices. As discussed in Box 4, the untapped potential of reforms to boost productivity and employment remains substantial. Alongside measures to improve public infrastructure, action to enhance the efficiency of insolvency frameworks and to increase competition in product and services markets would also help to boost investment and ultimately aggregate demand. As a complement to these reform priorities, comprehensive labour market reforms are needed to increase labour market flexibility, reduce segmentation between various types of employment contract and address skill mismatches. Policies aimed at human capital development and labour mobility as well as active labour market programmes should also be stepped up to tackle high unemployment. Greater efficiency in public administration would also spur productivity growth and benefit the private sector.

A renewed stimulus to reform implementation is also needed at the EU level. The new economic governance structure embodied in the Commission’s European Semester should foster reform implementation across the euro area, but the limited progress highlighted above shows that much more needs to be done. For example, as outlined in the Five Presidents’ Report^[34] published in 2015, a more binding convergence process towards resilient economic structures is needed in the medium to longer term. At the same time, pushing for more progress on the Single Market, establishing a true capital markets union and completing the banking union will also help to build a more resilient and growth-friendly euro area.

Monetary policy in support of the euro area recovery and a rise in inflation

The need for further monetary policy measures in 2016

Worsened economic and financial conditions warranted close monitoring at the start of the year

The monetary policy measures taken by the ECB in recent years have been geared towards supporting the euro area economic recovery and a return of inflation to levels below, but close to, 2% over the medium term. These measures, which include targeted longer-term refinancing operations (TLTROs), the asset purchase programme (APP) and the negative rate on the deposit facility, have been introduced in various steps and have proven to be very effective in underpinning the recovery and fending off disinflationary pressures. However, headwinds during 2016 delayed the convergence of inflation to levels in line with the Governing Council’s objective, necessitating further monetary policy action throughout the year.

At the start of 2016 economic and financial conditions deteriorated amid heightened uncertainty, geopolitical risks and more pronounced volatility in financial and commodity markets. In particular, concerns about the direction of the global economy increased in the light of the slowdown in emerging markets, especially in China. In addition, inflation dynamics continued to be weaker than expected, mainly owing to the renewed sharp fall in oil prices and subdued wage growth. In conjunction with declining short and medium-term inflation expectations, this signalled increased risks of second-round effects as there was a possibility that weak inflation expectations might cause wage-setting parties to delay wage increases.

Against this background, in January the Governing Council reaffirmed its forward guidance by emphasising that it expected the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases. Moreover, as the strength and persistence of the headwinds were uncertain, the Governing Council saw the need to review and possibly reconsider the monetary policy stance at the monetary policy meeting in March 2016, when more information, including the new staff projections, would be available.

In the first quarter the prospect of a sustained adjustment in the path of inflation towards the Governing Council’s objective of below, but close to, 2% over the medium term diminished. In particular, financial conditions tightened, especially in the equity and foreign exchange markets, carrying a risk of translating into tighter financing conditions for the real economy. Incoming information also indicated that the economic recovery had been losing momentum and inflation had declined again into negative territory. While much of this decline was due to falling oil prices, underlying price pressures were also weaker than previously anticipated. Medium-term market-based inflation expectations also decreased, increasing further the risks of second-round effects. The March ECB staff projections for inflation were revised down substantially, implying another postponement of the date at which inflation was projected to return to the Governing Council’s objective of below, but close to, 2%.

A gloomier outlook necessitated a forceful monetary policy response in March

Against this background, there was a strong case for the Governing Council to reconsider its monetary policy stance and provide further substantial monetary stimulus to counteract heightened risks to the ECB’s price stability objective. Consequently, the Governing Council introduced a comprehensive package of monetary policy measures in March 2016.

At its March meeting the Governing Council decided to: (i) lower the key policy rates, and in particular cut the rate on the deposit facility to -0.40%^[38]; (ii) expand the monthly purchases under the APP to €80 billion starting in April 2016 and increase the issuer and issue share limits for the purchases of certain types of securities; (iii) include a new corporate sector purchase programme (CSPP) in the APP, for purchasing investment-grade euro-denominated bonds issued by non-bank corporations established in the euro area; and (iv) launch a new series of four targeted longer-term refinancing operations (TLTRO-II), each with a maturity of four years, starting in June 2016. Moreover, the Governing Council continued to clarify in its forward guidance that the key ECB interest rates were expected to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases, and reaffirmed that the purchases should run until the end of March 2017, or beyond, if necessary, and in any case until the Governing Council saw a sustained adjustment in the path of inflation consistent with its inflation objective.

This comprehensive set of measures aimed to further ease private sector borrowing conditions and stimulate credit provision to the private sector, thereby reinforcing the momentum of the euro area recovery and accelerating the return of inflation to the desired levels. The measures also helped to mitigate pressure observed on the financial market earlier in the year and prevent it from undermining the pass-through of the accommodative monetary policy stance (see Section 2.2 of Chapter 1). The cut in the deposit facility rate was intended to induce a further easing of credit conditions (see Chart 23). That is, banks with liquidity holdings above the minimum reserve requirement would be incentivised to use the liquidity either to purchase other assets or to grant more loans to the real economy. In this way, the negative rate on the deposit facility reinforced the APP by strengthening portfolio rebalancing effects.

TLTRO-II was designed to be an important element of credit easing and credit creation, fostering the transmission of monetary policy through the bank lending channel. While the maximum interest rate to be charged was set at the rate on the main refinancing operations at allotment, the actual interest rate applied could be as low as the rate on the deposit facility if a particular bank’s lending exceeded its predefined benchmark.^[39]

The introduction of the CSPP further strengthened the pass-through of the Eurosystem’s asset purchases to the real economy. To benefit as many companies and sectors as possible, the universe of eligible assets was kept broad.^[40] CSPP purchases were in principle possible in both the primary and secondary markets.^[41]

The euro area showed resilience in the second half of 2016, but weakness in underlying inflation was protracted

The policy package decided upon in March 2016, together with the substantial monetary stimulus already in place, was instrumental in supporting the resilience of the euro area economy to global and political uncertainty. Following the outcome of the UK referendum on EU membership in mid-2016, financial market volatility initially increased, but markets overall showed encouraging resilience and calmed down again fairly quickly. The fact that central banks worldwide stood ready to provide liquidity, if needed, coupled with a stringent regulatory and supervisory framework for euro area banks, and the ECB’s accommodative monetary policy measures were conducive to this resilience.

At the same time, the potential future impact of the UK referendum outcome and other prevailing geopolitical uncertainties, together with subdued growth prospects in emerging markets, continued to weigh on foreign demand and were initially seen to pose downside risks to the euro area’s economic prospects for the second half of the year. This was also reflected in the September 2016 ECB staff macroeconomic projections, which revised the euro area growth forecast slightly downwards compared with the June exercise. In addition, underlying price pressures continued to lack a convincing upward trend and remained a source of concern. In particular, the outlook for growth and inflation in the euro area remained conditional on very supportive financing conditions, which to a large extent reflected the accommodative monetary policy stance.

The Governing Council therefore continued in the autumn to monitor economic and financial market developments very closely and underlined its commitment to preserve the very substantial amount of monetary support necessary to secure a sustained convergence of inflation towards levels below, but close to, 2% over the medium term. Moreover, to increase its readiness and capacity to act if needed, the Governing Council tasked the relevant Eurosystem committees with exploring options that would ensure a smooth implementation of the APP until March 2017, or beyond, if needed.

Towards the end of the year, the euro area recovery continued to show resilience in the face of prevailing uncertainties, aided by the continued strong pass-through of the monetary policy measures to the euro area real economy. The recovery proceeded at a moderate but firming pace, mostly on the back of strengthening domestic demand, real disposable income growth, sustained employment creation and still very favourable financing conditions. Inflation also picked up owing to rising energy prices and was set to recover further.

The December policy package aimed to preserve the very substantial degree of monetary accommodation

The scenario of a gradual uptrend in inflation still relied to a considerable degree on accommodative monetary policy support. Given the protracted weakness in underlying inflation, a sustained convergence of inflation towards the desired levels was seen as unlikely to be achieved with sufficient confidence. Against this background, preserving the very substantial degree of monetary accommodation beyond March 2017 was considered warranted.

Therefore, at its December meeting, the Governing Council decided to: (i) extend the horizon of its net asset purchases beyond March 2017 by announcing the continuation of the APP – alongside the reinvestment of maturing securities^[42] – at a monthly pace of €60 billion from April 2017 until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council saw a sustained adjustment in the path of inflation consistent with its inflation aim; and (ii) adjust the parameters of the APP as of January 2017 to ensure its continued smooth implementation, by decreasing the minimum remaining maturity for eligible securities under the public sector purchase programme from two years to one year and by permitting purchases of securities with a yield to maturity below the interest rate on the ECB’s deposit facility to the extent necessary.^[43] The key ECB interest rates were kept unchanged and the Governing Council continued to expect them to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases. Moreover, the Governing Council reaffirmed its commitment to closely monitor the evolution of the outlook for price stability and, if warranted to achieve its objective, to act by using all the instruments available within its mandate. In particular, the Governing Council emphasised that if, in the meantime, the outlook were to become less favourable, or if financial conditions were to become inconsistent with further progress towards a sustained adjustment of the path of inflation, it intended to increase the programme in terms of its size and/or duration.

These decisions aimed to ensure that financial conditions in the euro area remained very favourable, which continued to be crucial to achieve the ECB’s price stability objective. In particular, the extension of purchases under the APP over a longer horizon was intended to ensure more persistent support to financing conditions and, therefore, a more lasting transmission of the stimulus measures to underpin the moderate, but firming, recovery. At the same time, the more sustained market presence of the Eurosystem aimed to provide a source of stability in an environment of heightened uncertainty, including concerns stemming from the potential longer-term consequences of the UK referendum and from possible policy implications following the US presidential election. The reduction in the monthly pace of purchases reflected the Governing Council’s reassessment of the balance of risks, according to which confidence in the overall performance of the euro area economy had grown while deflation risks had largely disappeared. The decision overall aimed to protect financial conditions in the euro area and to allow the recovery to mature and strengthen, notwithstanding possible external or internal shocks.

The pass-through of monetary policy to financial and economic conditions

The ECB’s comprehensive policy measures continued to be effective in providing a substantial degree of accommodation

The monetary policy measures put in place since mid-2014, when the ECB first introduced broad-based easing policies, including credit easing, have been a key factor supporting the euro area recovery. The comprehensive policy measures – such as the asset purchases, targeted longer-term refinancing operations (TLTROs) and low policy rates – continue to filter through to the real economy. As a result, borrowing conditions for households and firms have eased considerably and credit creation has strengthened, thereby supporting aggregate spending across the euro area.

A substantial degree of accommodation stemmed from the net purchases under the asset purchase programme (APP), which encompasses purchases of a wide range of private and public sector securities under its four sub-programmes: the public sector purchase programme (PSPP), the asset-backed securities purchase programme (ABSPP), the third covered bond purchase programme (CBPP3) and the corporate sector purchase programme (CSPP). The implementation of the APP continued to run smoothly in 2016. The flexibility provided within the APP allowed the combined average monthly purchases to be kept in line with the target set by the Governing Council, i.e. at €60 billion per month, on average, from January to March 2016 and €80 billion per month for the rest of the year. The purchases were, however, somewhat lower in August and December, months usually characterised by lower market liquidity, and slightly higher in the other months. The PSPP continued to represent by far the largest share of the overall purchases (see Chart 24).

The pass-through of the ECB’s measures via financial markets and the banking system continued successfully

The impact of the ECB’s monetary policy measures on benchmark financial assets has been pronounced. In particular, the Eurosystem’s asset purchases and the low interest rate environment have contributed to the marked decline in money market rates and sovereign bond yields since mid-2014.^[50] The ECB’s monetary policy also helped to partly shield euro area bond market conditions from rising government bond yields in the United States at the end of 2016. The ECB’s measures have furthermore influenced developments in other segments of the financial markets. More specifically, portfolio rebalancing and positive macroeconomic effects associated with the very substantial degree of monetary accommodation may have supported the recovery in stock prices. The nominal effective exchange rate of the euro fell overall in 2016.

The ECB’s policy measures contributed to a significant improvement in banks’ funding conditions in two ways. First, bank funding instruments were among the asset classes that saw a substantial compression of medium-to-long-term yields. This was supported by portfolio rebalancing effects from Eurosystem asset purchases and by scarcity effects owing to lower bond issuance by banks, which instead borrowed under TLTROs.^[51] As a result, the composite cost of debt financing for banks decreased markedly (see Chart 25). Second, banks continued to replace more expensive, short-term market funding with TLTRO funding (and, in addition, used the option to roll over TLTRO-I with the cheaper TLTRO-II).^[52] Three out of the four planned TLTRO-II operations were conducted in 2016, while the fourth is scheduled for March 2017.^[53] The total take-up until end-2016 amounted to €506.7 billion, around 43% of euro area banks’ total borrowing allowance under TLTRO-II.

The overall impact of the APP and the negative deposit facility rate on bank profitability has been limited, as the impacts on different components of banks’ income largely offset each other (see Chart 26). On the one hand, the two measures compressed interest rates on a large set of financial assets, narrowed interest rate margins and thus contributed to lower net interest income. On the other hand, increases in the market value of sovereign bonds held by banks generated capital gains. In addition, the positive effects of the recent monetary policy measures on the economic outlook contributed to rising loan volumes and improving credit quality.

Euro area firms benefited from the ECB’s accommodative monetary policy stance

The pass-through of the monetary stimulus to bank lending conditions and credit creation has been remarkable. Interest rates have fallen markedly across a broad spectrum of asset classes and credit markets since June 2014. As a result, euro area firms and households have experienced more favourable borrowing conditions. For example, bank lending rates for companies declined by more than 110 basis points between June 2014 and December 2016 (see Chart 19).

The easing is also being felt by small and medium-sized enterprises (SMEs) – the backbone of the euro area economy – which are heavily reliant on bank credit. Bank lending conditions for SMEs have improved further: since May 2014 bank lending rates on very small loans to companies have declined by around 180 basis points. Moreover, in the Survey on the Access to Finance of Enterprises in the euro area, SMEs continued to report a further improvement in their access to credit and an increased willingness of banks to provide credit at lower interest rates.^[54] New bank credit to companies continues to be used mostly to finance investment projects, inventories and working capital.

The Eurosystem’s asset purchases and the low interest rate environment have incentivised banks to grant more loans, e.g. by reducing the attractiveness of investing in lower-yielding securities. At the same time, lowering the cost of TLTRO-II for banks actively engaged in lending also encouraged banks to extend more credit (as a bank can borrow more cheaply under TLTRO-II if its lending volume exceeds its benchmark). This supported an easing of credit standards and an improvement in the terms and conditions of bank loans, as indicated by the euro area bank lending survey.^[55] Consequently, in a context of increasing credit demand, the gradual recovery in lending to the euro area private sector continued. Between May 2014 and December 2016, the annual rate of growth of loans to households increased from -0.1% to 2.0% and that of loans to non-financial corporations (NFCs) increased from -2.9% to 2.3% (see Chart 27).

Initial evidence regarding the CSPP’s contribution to easier financing conditions for firms has been encouraging. The announcement of the CSPP on 10 March 2016 strongly supported the ongoing contraction in spreads between yields on bonds issued by NFCs and a risk-free rate (see Chart 28).^[56] Moreover, the CSPP contributed to the increase in the issuance of euro-denominated corporate bonds over the year (see Chart 29). Finally, as a result of portfolio rebalancing, the demand for bonds not eligible under the CSPP rose as well and was met by increased issuance. The CSPP also had important spillover effects on the financing conditions of enterprises, as banks faced with substitution of bank loans by corporate debt issuance reported higher competitive pressures and stronger margin compression on loans to large firms.

The implementation of the CSPP proceeded as envisaged at its launch, with purchases being well-diversified across ratings, sectors, countries and issuers. As at 31 December 2016 the Eurosystem held around €51 billion of non-bank corporate bonds issued by 225 different issuers.

The ECB’s accommodative policy significantly supported macroeconomic developments in the euro area

Overall, the monetary policy measures introduced by the ECB since June 2014 have had significant macroeconomic effects. Without these measures, both growth and inflation developments would have been substantially more subdued in 2016. In particular, deflation risk vanished, aided by the ECB’s measures.

The European financial sector: improving resilience in a weak profitability environment

A number of risks to euro area financial stability were identified in 2016 in the ECB’s regular assessment of the emerging risks and resilience of the financial system. The overall level of systemic stress in the euro area nevertheless remained contained. Although financial institutions often faced weak profitability, they in many cases improved their resilience, for example by increasing capitalisation levels.

2016 was the second full year in which the ECB performed its macroprudential and microprudential tasks following the establishment of the Single Supervisory Mechanism (SSM), comprising the ECB and the national competent authorities (NCAs) of euro area countries, in November 2014. The ECB also contributed to several important regulatory initiatives and to measures aimed at establishing the third pillar of the banking union, namely a European deposit insurance scheme.

Risks and vulnerabilities in the euro area financial system

The ECB assesses financial stability developments in the euro area and EU financial systems to identify any vulnerabilities and sources of systemic risk. It carries out this task together with the other central banks of the Eurosystem and the European System of Central Banks. The emergence of possible systemic risks in the financial system is addressed through macroprudential policies.

The ECB presents its financial stability analysis in its semi-annual Financial Stability Review.^[60] The ECB also provides analytical support to the European Systemic Risk Board in the area of financial stability analysis.

Bouts of turbulence in global financial markets in 2016 and concerns about euro area banks’ profitability prospects

The overall level of systemic stress in the euro area remained contained during 2016 despite short bouts of turbulence in global financial markets. These included the deterioration in market sentiment around the beginning of the year, triggered by volatility in Chinese stock prices and concerns about emerging markets and, later in the year, the political uncertainty that followed the outcomes of the UK referendum on EU membership and the US presidential election. Euro area banks’ stock prices experienced periods of high volatility in 2016 which, overall, contributed to an increase in the estimated cost of equity. One of the main reasons for this continued to be market concerns about euro area banks’ profitability prospects in an environment of low growth and low interest rates. At the same time, continued accommodative monetary policy and abating market concerns about China dampened the spikes in euro area systemic stress, with standard indicators of bank, sovereign and financial stress remaining at low levels at the end of 2016 (see Chart 30).

In this environment, four key risks to euro area financial stability were identified during 2016 (see Table 2). The possibility of a global risk repricing increased given higher political uncertainty, vulnerabilities in emerging markets and the relatively low pricing of risk in the markets. At the same time, investors continued to increase the levels of risk in their portfolios in the low interest rate environment. Regarding asset prices, corporate bond yields remained at low levels in 2016, while some stock markets showed signs of being overvalued. There were also emerging signs of overvaluation for residential and commercial property in some countries.

Other key challenges in 2016 were in many ways a legacy of the banking and sovereign debt crises. The euro area banking sector remained vulnerable, despite its resilience to the market stresses described above. The weak economic growth and the associated low interest rate environment challenged bank profitability prospects in advanced economies (see Chart 31). Despite these challenges, banks have significantly strengthened their capital positions in recent years (as also confirmed by the results of the European Banking Authority’s 2016 EU-wide stress test).

In some euro area countries, profitability prospects were also hampered by structural overcapacity and the still incomplete adjustment of business models to the low interest rate environment (see Box 7).

Furthermore, the stock of non-performing loans (NPLs) remained high in some euro area countries, which raised concerns about future bank profitability and financial stability (see Box 8). Moreover, progress in reducing the level of NPLs remained slow. At the bank level, the reasons for this included inadequate operational capacity, a lack of experience in managing NPLs, capital constraints and low profitability. In addition, structural factors, such as inefficient insolvency laws, bottlenecks in judicial systems, a lack of out-of-court workout schemes, an underdeveloped market for NPLs, and accounting and tax issues, impeded the swift resolution of NPLs.^[61]

Financial stability risks also emanated from outside the banking sector in 2016. First, debt sustainability concerns for the sovereign and non-financial sectors increased. Second, risk-taking in the rapidly growing investment fund sector also increased. Although euro area investment funds remained resilient to market stress, the outflows from some property funds in the United Kingdom following the referendum result demonstrated the vulnerabilities of open-end funds (funds which can issue an unlimited amount of shares, with investors being able to redeem their investment at any time). The risks were aggravated by the lack of a systemic perspective in the regulation of the sector and the ensuing difficulty in preventing the build-up of sector-wide risks.

A structural analysis of the broader euro area financial sector, including insurance corporations and pension funds and shadow banking entities, confirmed that the non-banking financial sector continued to expand in 2016.^[62] At the same time, the banking sector continued to move towards more traditional business in 2016. A shift from central bank and wholesale funding towards deposit funding was accompanied by a decrease in leverage.

The ECB’s macroprudential function

The responsibility for decisions on macroprudential measures in the euro area is shared between national authorities and the ECB. National authorities retain the power to implement macroprudential measures, but the ECB has the power to top up the measures taken by national authorities for those macroprudential instruments assigned to it through EU legislation. The asymmetric nature of the powers reflects the role that the ECB is required to play to overcome a potential inaction bias at national level.

In 2016 the ECB and national authorities continued to engage in broad discussions, at both the technical and the policy level, on the use of macroprudential instruments. These discussions served to assess the adequacy of the macroprudential stance across all the countries covered by European banking supervision.

Macroprudential policy during 2016

During 2016 the ECB strengthened its coordination role in macroprudential policy and its external communication on macroprudential issues to improve transparency and to underscore the important role that macroprudential policy plays. The Governing Council released its first macroprudential statement following discussions at the Macroprudential Forum, which is composed of the members of the Governing Council and the Supervisory Board of the ECB. In addition, the first two issues of the ECB’s Macroprudential Bulletin were released in March and October. The aim of the Bulletin is to enhance the transparency of macroprudential policy, to provide information about ongoing research on macroprudential topics and to illustrate how it is applied in dedicated policy work at the ECB. The first issue of the Bulletin also discussed the ECB’s macroprudential policy framework and how it relates to other macroprudential fora and processes in the EU.^[69]

The ECB also fulfilled its legal mandate to assess macroprudential decisions of national authorities in the countries covered by European banking supervision. It received notifications of over a hundred such decisions, most of which were related to the setting of countercyclical capital buffers and to the identification of systemically important credit institutions and the calibration of their capital buffers. In addition, the ECB received notifications on the implementation of the systemic risk buffer and risk weight floors in some countries.

On a quarterly basis all 19 euro area countries assess cyclical systemic risks and set the level of the countercyclical capital buffer. Cyclical systemic risks have remained contained in most of the euro area countries. The Governing Council agreed with the countercyclical capital buffer decisions taken by the national authorities. In particular, the significant build-up of cyclical systemic risks in Slovakia led to the decision to set the countercyclical capital buffer in Slovakia at 0.5% as of 1 August 2017.

In 2016 the ECB, national authorities and the Financial Stability Board (FSB), in consultation with the Basel Committee on Banking Supervision (BCBS), updated the assessment of global systemically important banks (G-SIBs) in euro area countries. The assessment resulted in eight banks in France, Germany, Italy, the Netherlands and Spain being allocated to the internationally agreed G-SIB buckets 1 and 3, which entail capital buffer rates of 1.0% and 2.0% respectively.^[70] These new buffer rates are applicable from 1 January 2018 and subject to a phase-in period. The lists of G-SIBs and other systemically important institutions (O-SIIs) and their buffer rates are reviewed on an annual basis.

National authorities also decided on the capital buffers for the 110 O-SIIs. The decided buffer rates are in line with the newly introduced ECB methodology for assessing O-SII buffers.^[71] All of the identified O-SIIs will have a strictly positive capital buffer rate as of 2019.

Macroprudential stress testing

As part of its macroprudential function, and in addition to actively participating in the EU-wide supervisory stress test in 2016, the ECB carried out a macroprudential extension of the stress-test exercise.^[72] Whereas the supervisory stress test focuses on estimating the direct impact on individual banks’ solvency, the macroprudential extension aimed to quantify the potential second-round macroeconomic effects of the stress materialisation. The study was based on a conceptual framework developed by ECB staff which will be used to support the calibration of macroprudential policy measures.^[73]

The first step was to estimate the impact of changes in the stock of aggregate bank loans on bank solvency, thus removing part of the inconsistency introduced by the static balance sheet assumption used in the EU-wide stress-test methodology. In an additional step, second-round effects on macroeconomic variables were estimated. These relate to banks’ potential adjustments when their capital ratio falls below a predetermined capital target in the adverse scenario. Their magnitude depends on the adjustment strategy adopted: the greater the share of equity issuance in the adjustment, the smaller the second-round macroeconomic impact.

Beyond the endogenous response of the banking sector to stress, the macroprudential extension considered two additional channels through which second-round effects of distress can further reduce bank solvency, namely bank interconnectedness and cross-sector spillovers through equity holdings. The exercise concluded that direct contagion through interbank money markets should be limited, while cross-sector spillovers would mostly affect non-bank financial institutions, in particular investment funds and pension funds.

Cooperation with the European Systemic Risk Board

The ECB continued to provide analytical, statistical, logistical and administrative support to the ESRB Secretariat, which is in charge of the day-to-day operations of the ESRB. The Financial Stability Committee of the ECB prepared jointly with the Advisory Scientific Committee and the Advisory Technical Committee of the ESRB a report on the macroprudential policy issues arising from low interest rates and structural changes in the EU financial system.^[74] The report explores potential risks in a low interest rate environment across financial sectors and highlights possible macroprudential policy responses. It covers not only banks but also other types of financial institution, financial markets and market infrastructure, overarching issues across the financial system, and interactions with the broader economy.

The ECB also supported the ESRB in its publication of eight country-specific warnings on residential real estate vulnerabilities on 28 November 2016 by analysing indicators of imbalances and developing overvaluation models. The highlighted vulnerabilities related to rising household indebtedness and households’ ability to repay their mortgage debt, as well as to the valuation or price dynamics of residential real estate. Notwithstanding this analysis, real estate data gaps need to be closed further, as reflected in an ESRB recommendation providing harmonised definitions necessary to conduct data collections related to both the residential and the commercial real estate sectors.

The ECB’s microprudential function

2016 was the second full operational year for ECB Banking Supervision. Throughout the year, activities in this area continued to contribute to a stable European banking sector and a level playing field for all banks in the euro area.

The ECB refined the Supervisory Review and Evaluation Process (SREP) for those banking groups that it supervises directly, publishing high-level expectations on banks’ internal capital and liquidity adequacy assessment processes as well as a recommendation on banks’ dividend distribution policies. Moreover, it took into account clarifications from the European Commission and the European Banking Authority (EBA). Supervisory capital add-ons now consist of two components: the requirement which banks have to fulfil and maintain at all times, and the guidance the breach of which would not automatically lead to supervisory action but would trigger a case-by-case assessment and potentially bank-specific measures. In the 2016 SREP, the guidance reflected the results of the stress test conducted by the EBA. Overall capital demand remained broadly stable, unaffected by the changed methodology.

Less significant institutions (LSIs) are supervised by the national competent authorities (NCAs) under the oversight of the ECB. The ECB follows a proportionate, risk-based approach to the oversight of LSIs, complemented with sectoral monitoring to capture the interconnections among LSIs. The ECB and the NCAs continued to develop joint standards for supervising LSIs, for example establishing a joint monitoring of institutional protection schemes^[75] which cover both significant institutions (SIs) and LSIs.

European banking supervision further harmonised the exercise of options and discretions provided in European prudential legislation. This is an important step towards ensuring consistent supervision and a level playing field for SIs and LSIs. Still, the regulatory framework in the euro area remains fragmented in some cases. Given the goal of a European banking union, further harmonisation is necessary.

Against the backdrop of low profitability in the European banking sector, the ECB examined banks’ business models and profitability drivers and launched a thematic review. The ECB also devised guidance for banks on how to tackle non-performing loans, which remain high in some parts of the euro area. In June the ECB published a supervisory statement on banks’ governance and risk appetite, outlining supervisory expectations. It also launched a targeted review of banks’ internal models, conducted a stocktake of IT risks and prepared guidance on leveraged transactions.

ECB Banking Supervision also increased its participation in global fora by becoming a member of the plenary of the Financial Stability Board.

More detailed information on ECB Banking Supervision can be found in the ECB Annual Report on supervisory activities 2016.

The ECB’s contributions to regulatory initiatives

The ECB contributed to the development of the regulatory framework at the international and European levels in 2016. The primary objective of the ECB was to ensure that the regulatory framework appropriately takes into account both macro- and microprudential considerations and to create a framework that supports the stability of the individual institutions and the financial system as a whole. The key regulatory issues for the ECB in 2016 included: (i) the finalisation of the international capital and liquidity standards for banks (Basel III); (ii) the revision of the micro- and macroprudential regulatory framework in the European Union (the Capital Requirements Regulation and Directive – CRR/CRD IV); (iii) ending the “too big to fail” problem; and (iv) creating a capital markets union (CMU) for the European Union and strengthening the regulatory framework beyond the banking sector. In addition, the ECB contributed to the continued discussions in 2016 on establishing the third pillar of the banking union, namely a European deposit insurance scheme.

The finalisation of the international capital and liquidity standards for banks

In 2016 the ECB contributed to a number of initiatives aimed at completing the regulatory response to the financial crisis, which also entailed a comprehensive overhaul of the prudential framework for banks over the last eight years by the Basel Committee on Banking Supervision (BCBS). Basel III is a core element of the post-crisis reforms which aims to ensure adequate, internationally comparable standards and give banks a degree of regulatory certainty to support the adaptation of business models to the current environment. In this context, the ECB contributed to the comprehensive review of the use of internal models in the Basel capital framework, an exercise aimed at reducing excessive variability of risk-weighted assets, which form the basis of capital requirements. Moreover, the ECB supported the BCBS and the European Banking Authority (EBA) in their work on finalising the leverage ratio as a backstop measure to the risk-based capital requirements, in particular with regard to the calibration of an adequate minimum level, as well as a surcharge for global systemically important banks (G-SIBs) based on an internationally harmonised definition. In January 2017 the Group of Governors and Heads of Supervision (GHOS), the oversight body of the BCBS, welcomed the progress made towards completing the post-crisis regulatory reforms. It noted, however, that more time was needed to finalise the reform proposals before the GHOS could review them. This work is expected to be completed in the near future.

The revision of the micro- and macroprudential regulatory framework in the European Union

The implementation of the agreed international standards in EU law, notably via the revision of the CRR/CRD IV, was one of the main regulatory challenges in 2016, and this will continue to be the case in the years ahead. The review of the CRR/CRD IV will introduce the leverage ratio into the EU framework, as an additional capital-based measure complementing the risk-based capital framework, as well as the net stable funding ratio, which is a long-term liquidity requirement complementing the existing short-term requirements set by the liquidity coverage ratio. Furthermore, by setting proper incentives for banks and their employees, the new framework will also contribute to a more stable provision of financial services to the real economy. This review, which is expected to be completed in 2017, represents an important phase of regulatory reform in the European Union.

A further key regulatory initiative to which the ECB made a substantial contribution is the review of the EU macroprudential policy framework which started in 2016. The ECB is supportive of a comprehensive review of the macroprudential policy framework with the aim of enhancing its effectiveness, and in 2016 an ECB contribution to the European Commission’s consultation on the review was published.^[76] In this regard, it is important to reflect the new institutional landscape, notably the establishment of the Single Supervisory Mechanism (SSM), in the macroprudential policy framework, as well as to revise and clarify the specific powers of micro- and macroprudential authorities, streamline the coordination arrangements between authorities, broaden the macroprudential policy tools and simplify their activation mechanism so as to ensure that authorities can address systemic risks in a timely and effective manner. This requires a thorough revision of the current legislation because the macroprudential framework set out in the CRR/CRD IV as well as in the ESRB Regulation^[77] predates the establishment of the banking union and in particular of the SSM.

Ending the “too big to fail” problem

The revision of the recovery and resolution framework was another key regulatory initiative to which the ECB contributed in 2016. The objective of the revision is to ensure that banks have sufficient and credible loss-absorbing capacity and that the costs of resolution are borne by banks’ shareholders and creditors, rather than taxpayers. A new concept of total loss-absorbing capacity (TLAC) has already been agreed for G-SIBs at the international level. In parallel, the EU framework introduced a minimum requirement for own funds and eligible liabilities (MREL), which is applicable to all credit institutions in the European Union, irrespective of their size. Both TLAC and MREL requirements improve the resolvability of banks and thus safeguard financial stability and avoid both moral hazard and the overburdening of public finances. However, the two concepts deviate in terms of some key features, which may create inconsistencies in the regulatory framework and may also distort competition. In this regard, the ongoing revision of the Bank Recovery and Resolution Directive and other related pieces of EU law provides an opportunity to implement TLAC in Europe at least for G-SIBs and to further harmonise the application of MREL across EU Member States, thus ensuring that globally active institutions face a consistent set of rules across jurisdictions.

Financial regulation beyond banking

It is important that an appropriate regulatory framework is also in place for non-bank financial institutions. To this end, the ECB contributed to the discussion on the completion of the Single Market for financial services and capital, which entails further levelling the playing field between the banking and non-banking sectors and making real progress on the CMU Action Plan. Greater financial risk-sharing, diversification and heightened competition between bank and non-bank entities and across borders bring economic benefits. Indeed, capital markets can be an important complement to banks when it comes to providing finance to the economy. At the same time, such developments inevitably have financial stability implications and may create new risks.

The ECB in 2016 continued to support the steps to accelerate CMU. A fully fledged CMU needs to tackle differences in the national and European legislative frameworks which pose an obstacle to cross-border activities, including insolvency law and taxation. It is also important to establish the legal basis for macroprudential tools that can be used beyond the banking sector.

A European deposit insurance scheme

The ECB contributed to the continued discussions in 2016 on establishing a European deposit insurance scheme and supports the roadmap towards completing banking union, including risk-sharing (comprising the scheme itself plus a backstop to the Single Resolution Fund) and related risk-reduction measures.

In the ECB’s view, it is important that such a scheme is put in place as soon as possible and that progress continues to be made on the risk-reduction agenda. A European deposit insurance scheme is the third and final pillar of banking union and its establishment would further enhance and safeguard financial stability. Deposit insurance is both an ex ante tool to enhance confidence and prevent bank runs and an ex post tool to protect against the adverse consequences of individual bank failures. In parallel, progress should continue on implementing remaining reforms which will contribute to reducing risks in the banking system.

Other tasks and activities

Market infrastructure and payments

The financial sector, including its underlying market infrastructure, needs to adjust to the rapid technological change and innovation which is currently having an impact on all aspects of our lives. While digitalisation, globalisation and greater interconnectivity have opened up new opportunities for individuals and businesses to obtain information, transact business and communicate, the increase in users and data on digital platforms, in cloud computing and across networks has also increased the number of potential routes for cyber attacks. Cybercrime poses threats not only to individual market participants but also to the overall operational network, and cyber resilience was therefore an important focus point for the ECB and the Eurosystem in 2016 in the area of market infrastructure and payments.

The Eurosystem has also been looking at the future strategic development of its market infrastructure. It is exploring how liquidity management within the fields of payments, securities settlement and Eurosystem collateral management can be made more efficient. Working closely with market participants, it is studying how new user needs can be met and how technological innovation can be used to stay ahead of evolving risks, such as cyber threats.

In shaping the future of its market infrastructure, safety and efficiency remain the top priorities for the Eurosystem. The smooth operation of its market infrastructure is crucial for maintaining confidence in the euro and supporting monetary policy operations. It also plays a central role in ensuring the stability of the European financial system and in boosting economic activity.

Consolidation of TARGET2 and T2S

TARGET2, the Eurosystem’s gross settlement system for euro payment transactions, processed a daily average value of €1.7 trillion in 2016. To give an idea of the magnitude of this figure, TARGET2 processes a volume comparable to the euro area’s annual GDP every six days.

TARGET2-Securities (T2S) went live in June 2015, bringing more integration into the European securities settlement market infrastructure, which was highly fragmented. The platform is an essential cornerstone of the European Commission’s project to build a capital markets union and has brought about an extensive post-trade harmonisation agenda.

Two successful migration waves in March and September 2016 increased the number of central securities depositories (CSDs) on the T2S platform from 5 to 12^[82] and increased the processing volume to about 50% of the total volume expected by the time the remaining nine participating CSDs are connected to the platform. It is anticipated that T2S will process an average of more than 550,000 transactions per day once full migration is completed in 2017.

Functionally, TARGET2 and T2S revolve around efficient liquidity management within the fields of payment transfers, securities settlement and collateral management. However, as the two systems were developed at different points in time, they operate on separate platforms and use different technical solutions and environments. It is therefore logical to seek synergies between the two systems. Modernising TARGET2, leveraging the possibilities already available in T2S, and consolidating the technical and functional components of TARGET2 and T2S services are the primary objectives. In addition, consolidation provides an opportunity to further improve cyber resilience, to enhance the services offered to users and to establish a single access channel. Investigative work in this area will run throughout 2017.

Settlement services to support instant payments

For the Eurosystem, the biggest challenge posed by digitalisation in the payments industry is to ensure that the introduction of innovative payment products and services developed by the market does not reintroduce fragmentation into the European market.

In 2016 instant payments, i.e. payments with immediate availability of funds to the recipient, were probably the most talked about topic in the retail payments industry. The instant payment scheme launched in November 2016 enables the roll-out of instant payment solutions to end users. By November 2017 the European financial market infrastructure aims to be ready to process instant payments on a pan-European scale.

The Eurosystem will support settlement between retail payment infrastructures offering clearing services for pan-European instant payments in euro by delivering enhanced TARGET2 functionality for automated clearing houses (ACHs) and by fostering dialogue and interoperability between ACHs.

Furthermore, the Eurosystem, in the context of its investigative work on the future of its market infrastructure, is analysing the possibility of developing a real-time TARGET instant payment settlement service with settlement in central bank money available at any time all year round.

The Eurosystem’s future market infrastructure and distributed ledger technology

In the context of its strategic reflections on the future of the Eurosystem market infrastructure, the ECB has been considering a range of distributed ledger technology (DLT) models that are currently under development. To gain more insight into the possible impact of DLT on market infrastructure, see the special feature on the ECB’s website.

A safe financial market infrastructure

The Eurosystem promotes the safety and efficiency of financial market infrastructures (FMIs) through its oversight role and, where necessary, fosters change. In July 2016 the ECB published a revised version of the Eurosystem oversight policy framework to reflect regulatory and other developments over recent years which have influenced the Eurosystem oversight function. The ECB is the lead overseer of three systemically important payment systems (SIPS) – TARGET2, EURO1 and STEP2. During 2016, together with euro area national central banks (NCBs), the ECB concluded a comprehensive assessment of these SIPS against the oversight requirements of the SIPS Regulation^[83]. The ECB also expanded its oversight activities in relation to T2S in line with the increased migration of CSDs to the single settlement platform over the course of 2016.

Furthermore, the ECB published a report on a crisis communication exercise for FMIs operating in the euro area that was organised by Eurosystem overseers. The market-wide exercise was designed to evaluate the preparedness of the Eurosystem to effectively carry out its operational and oversight responsibilities during crisis events and to provide assurance on the effectiveness of the various stakeholders’ crisis management procedures for events with cross-border impacts. More generally, the ECB is working together with other central banks, regulators and authorities to strengthen the resilience of the financial sector as a whole against cyber attacks and contributed to international guidance on cyber resilience^[84] which was issued in 2016.

With regard to central counterparties (CCPs), the ECB has contributed to the international efforts under the aegis of the relevant G20 standard-setting bodies to complete the reform of global derivatives markets.

The ECB continued to be involved in global and EU cooperative arrangements for certain FMIs from a central bank of issue perspective. In this context, the ECB contributed to the ongoing work of the supervisory colleges for CCPs established under the European Market Infrastructure Regulation (EMIR). From the same perspective, the ECB, together with euro area NCBs, carried out preparatory work on the future authorisation of CSDs under the CSD Regulation.

Financial services provided to other institutions

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 facility (MTFA)^[85] and the European Financial Stabilisation Mechanism (EFSM)^[86]. In 2016 the ECB processed interest payments in relation to the loans under the MTFA. As at 31 December 2016 the total outstanding amount under this facility was €4.2 billion. In 2016 the ECB also processed various payments and interest payments in relation to the loans under the EFSM. As at 31 December 2016 the total outstanding amount under this mechanism was €46.8 billion.

Similarly, the ECB is responsible for the administration of payments arising in connection with the operations under the European Financial Stability Facility (EFSF)^[87] and the European Stability Mechanism (ESM)^[88]. In 2016 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.^[89] As at 31 December 2016 the total outstanding amount under this agreement was €52.9 billion.

Eurosystem Reserve Management Services

In 2016 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. Individual Eurosystem NCBs (“the Eurosystem service providers”) offer the complete set of 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 286 in 2016, compared with 285 in 2015. With regard to the services themselves, in the course of 2016 the total aggregated holdings (which include cash assets and securities holdings) managed within the ERMS framework increased by approximately 8% compared with the end of 2015.

Banknotes and coins

The ECB and the euro area national central banks (NCBs) are responsible for issuing euro banknotes within the euro area and for maintaining confidence in the currency.

The circulation of banknotes and coins

In 2016 the number and value of euro banknotes in circulation grew by around 7.0% and 3.9% respectively. At the end of the year there were 20.2 billion euro banknotes in circulation, with a total value of €1,126 billion (see Charts 32 and 33). The €100 and €200 banknotes showed the highest annual growth rates, which reached 13.4% and 12.9% respectively in 2016. Growth in the €50 banknote remained dynamic, at 9.9%, but was slightly slower than in the previous year.

Following a review of the denominational structure of the second series of euro banknotes, known as the Europa series, the Governing Council decided to stop the production of the €500 banknote and to exclude it from the Europa series, taking into account concerns that this banknote could facilitate illicit activities. The issuance of the €500 banknote will be stopped around the end of 2018, close to the planned introduction of the €100 and €200 banknotes of the Europa series. The other denominations – from €5 to €200 – will remain in place. The production of euro banknotes is shared between the euro area NCBs, which were altogether allocated the production of 6.22 billion banknotes in 2016.

In view of the international role of the euro and the widespread trust in euro banknotes, the €500 banknote will remain legal tender and can therefore continue to be used as a means of payment and store of value. The €500 banknote, like the other denominations of euro banknotes, will always retain its value and can be exchanged at the euro area NCBs for an unlimited period of time.

Following the decision to stop issuing the €500 banknotes, the circulation of the €500 banknote decreased in 2016. This decline was partly compensated for by a higher demand for the €200, €100 and €50 banknotes.

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 on international markets.

In 2016 the total number of euro coins in circulation increased by 4.2%, standing at 121.0 billion at end-2016. At the end of 2016 the value of coins in circulation stood at €26.9 billion, 3.6% higher than at the end of 2015.

In 2016 the euro area NCBs checked the authenticity and fitness for circulation of some 32.3 billion banknotes, withdrawing around 5.4 billion of them from circulation. 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 fitness prior to recirculation. In 2016 credit institutions and other professional cash handlers checked some 33 billion euro banknotes for authenticity and fitness using such machines.

A new €50 banknote

On 5 July 2016 the new €50 banknote, which will enter into circulation on 4 April 2017, was unveiled. The introduction of the new note is the latest step in making euro banknotes even more secure. After the €5, €10 and €20, the new €50 is the fourth denomination of the Europa series to be introduced. It contains enhanced security features, including the “emerald number”, which displays an effect of the light that moves up and down when the banknote is tilted and also changes colour, and a “portrait window” – an innovative feature first used on the Europa series €20 banknote. When the banknote is held up to the light, a transparent window near the top of the hologram reveals a portrait of Europa (a figure from Greek mythology), which is visible on both sides of the note. The same portrait also appears in the watermark.

In preparation for the introduction of the new €50 banknote, the ECB and the euro area NCBs conducted a campaign to inform both the public and professional cash handlers about the new banknote and its features. They also took several measures to help the banknote handling machine industry prepare for the introduction of the new banknote.

Counterfeit euro banknotes

The total number of counterfeit euro banknotes decreased in 2016, with around 685,000 counterfeits being withdrawn from circulation. Compared with the number of genuine euro banknotes in circulation, the proportion of counterfeits is very low. Long-term developments in the quantity of counterfeits removed from circulation are shown in Chart 34. Counterfeiters tend to target the €20 and €50 banknotes, which in 2016 accounted together for around 80% of the total number of counterfeits seized. The share of counterfeit €20 banknotes fell in 2016.

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 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.

Statistics

The ECB, assisted by the NCBs, develops, collects, compiles and disseminates a wide range of statistics which are important to support the monetary policy of the euro area, the supervisory functions of the ECB, various other tasks of the ESCB and the tasks of the European Systemic Risk Board. These statistics are also used by public authorities, financial market participants, the media and the general public.

In 2016 the ESCB continued to provide regular euro area statistics in a smooth and timely manner. In addition, it devoted considerable efforts to fulfilling new demands for very timely, high-quality and more granular statistics at the country, sector and instrument levels. Such demands have resulted in the need to “move beyond the aggregates”, a theme to which the ECB devoted its 8th Statistics Conference in July 2016.^[90]

New and enhanced euro area statistics

In July 2016 the ECB started the daily collection of transaction-level data on the euro money market from the largest euro area banks, covering the main market segments (i.e. the secured, unsecured, foreign exchange swap and overnight index swap segments), with around 45,000 transactional records per day. This information will support several policy functions and will enable the publication of new statistics.

New enhanced statistics on insurance corporations have been collected under Regulation ECB/2014/50 (and the Solvency II Directive) for the first and second quarters of 2016. These data are the result of a multi-year collaboration between the ECB and the European Insurance and Occupational Pensions Authority and between NCBs and national competent authorities to minimise the reporting burden on the industry. The data are being assessed and aggregated ahead of their planned publication in 2017.

In April 2016 the euro area international investment position included for the first time a complete stock-flow reconciliation, and the quarterly euro area accounts included “who-to-whom” data for securities in addition to deposits and loans.

In September 2016 the ECB started publishing the monthly ECB and Eurosystem international reserves and foreign currency liquidity templates with a time lag of 15 days, advancing their publication by 15 calendar days.

In November 2016 the ECB started to publish additional and more detailed quarterly data on the financial health of significant banks supervised directly by the ECB, with some statistics available by country and category. This will enhance transparency concerning the quality of banks’ assets and support market discipline.

In December 2016 the ECB published the results of the second wave of the Household Finance and Consumption Survey, which covered more than 84,000 households in the euro area (except Lithuania) as well as in Hungary and Poland (see also Section 5 of Chapter 2). The analysis of the survey’s findings will enable a better understanding of how microeconomic heterogeneity affects macroeconomic outcomes.

Other statistical developments

The ESCB continued to develop new or substantially improved microdata platforms as a primary source for its statistics. Although granular information implies a greater burden for the ESCB statistical function in terms of data processing and quality assurance, it has the potential advantage of reducing the burden on reporting agents. Moreover, it allows flexibility and agility in adapting to user needs and increases the quality and internal consistency of the data collected.

The Centralised Securities Database output was extended to facilitate, among other things, the management of collateral.

In May 2016 the ECB approved a new statistical Regulation (ECB/2016/13) establishing a granular database comprising harmonised data on credit and credit risk for the Eurosystem. The AnaCredit dataset will deliver, as of end-2018, monthly loan-by-loan information on credit granted by euro area banks and their foreign branches to companies and other legal entities as defined in the Regulation (no natural persons will be covered). In parallel, the capacity of the ESCB Register of Institutions and Affiliates Database (RIAD) will be extended to incorporate the necessary information on non-financial corporations.

In August 2016 the ECB amended the Regulation and Guideline concerning statistics on holdings of securities in order to collect additional accounting and credit risk attributes from banking groups. In addition, the list of reporting banking groups will be extended to cover all significant groups directly supervised by the ECB. Furthermore, the amended Guideline establishes a data quality management framework for assessing and ensuring the quality of output data.

The ESCB attaches great importance to the quality of its statistics, while trying to keep the reporting burden to a minimum. In this respect, the integration of statistical and supervisory requirements is essential to streamline the overall process of reporting by banks to national and European authorities. Three main workstreams in this field relate to: (i) the development of the Banks’ Integrated Reporting Dictionary in cooperation with the industry, defining common rules to be applied by banks when reporting to the authorities^[91]; (ii) the definition of a Single Data Dictionary for the Eurosystem and the SSM; and (iii) the establishment of a single, harmonised European Reporting Framework for banks.

In October 2016 the ECB decided to further enhance the transparency of the impact assessment undertaken for new ECB regulations on European statistics, by conducting, if deemed necessary, a public consultation in addition to the merits and costs procedure which has been carried out since 2000.

In November 2016 the European Commission and the ECB signed a Memorandum of Understanding between Eurostat and the ECB’s Directorate General Statistics on the quality assurance of statistics underlying the macroeconomic imbalance procedure.

In 2016 the ECB also continued to make its statistics more accessible and user-friendly, for example through a new search functionality in the Statistical Data Warehouse, dynamic graphs, an updated ECBstatsApp, and new explainers on the ECB’s “Our statistics” website.

Economic research

The production of high-quality scientific research helps provide solid and rigorous foundations for the ECB’s policy analysis and thereby makes an important contribution to the achievement of policy objectives. During 2016 economic research at the ECB provided new insights into many challenging and shifting analytical priorities. In addition, the activities of three research networks fostered intense collaboration among researchers throughout the ESCB.^[92]

ECB research priorities and clusters

Research conducted at the ECB is organised around seven research groups, which encompass a wide range of economic and financial topics (see Figure 1). These teams help coordinate the bank’s research agenda across business areas. Furthermore, to best exploit the wide array of research talent that exists across the ECB, the groups cooperate with each other on topics that are of common interest. In 2016 ECB research teams focused on four key research priorities (see Figure 2), delivering insights linked to the transmission of monetary policy, the factors behind low inflation and the functioning of new institutional arrangements in EMU. Outside of these key areas, research also focused on the modest growth performance of the euro area, the global economic environment, banking and microprudential policy as well as model development and refinement. With regard to the latter, the focus has been on the development of more up-to-date country and euro area-wide models intended to capture more thoroughly the interactions between the financial and real sectors of the economy.

Eurosystem/ESCB research networks

Eurosystem/ESCB research networks made significant progress during 2016, with all three networks delivering important insights into the functioning of the EU and euro area economies.

The Wage Dynamics Network (WDN) completed the third wave of its survey, aimed at assessing how firms in the EU have reacted to the various shocks and structural reforms that took place during the period 2010-13. The survey covers over 25,000 firms from 25 EU countries and yields a fully harmonised dataset which permits rigorous cross-country analysis. In the course of the year the network published country-level reports presenting key findings as well as an article in the ECB’s Economic Bulletin highlighting extensive new evidence on wage adjustment. A key insight uncovered by this work is that the frequency of wage changes in EU countries was lower during the period 2010-13 than in the pre-crisis period (2002-07) and that this seems to be at least partly attributable to the resistance of firms to lower base wages, though the latter was lower in countries subject to a macroeconomic adjustment programme.

The Household Finance and Consumption Network coordinates the production of the Household Finance and Consumption Survey and analyses the resulting data, with the ultimate objective of understanding how differences across consumers can help explain aggregate economic developments. In 2016 this network released a report presenting the results of the second wave of the survey covering more than 84,000 households in 20 countries. A key focus of the survey is on household wealth and its distribution across households (see Chart 35). The median household holds net wealth of €104,100; the 75th percentile of the distribution is €258,800, the 90th €496,000 and the 95th €743,900.The network conducted research on several broad areas, including: the determinants of consumption; the study of the financial fragility of households for the assessment of macroprudential tools; the distributional effects of asset prices and monetary policy^[93]; the measurement of the wealth distribution across households; and the response of consumer spending to tax policy.

In the course of 2016 the Competitiveness Research Network continued to function as a hub for ESCB researchers in the area of competitiveness and productivity analysis. Research output was particularly rich with regard to international trade, the international transmission of economic shocks, and the efficiency of resource allocation in the EU. One major output of the network in 2016 was the collection and release of the fifth vintage of the network’s EU firm-level dataset. The dataset consists of a comprehensive set of indicators related to productivity and is unique in terms of cross-country comparability and coverage. Research with these new data provided insights into the link between productivity gains and employment creation in the euro area.

Conferences and publications

In recent years cutting-edge research and dialogue with economists working in academia have become increasingly important as the number and complexity of issues relevant to the ECB have grown. With this in mind, the ECB organised several high-level research events in 2016 which focused on some of the most pressing issues facing central banks. Two major highlights of the year were the ECB Forum on Central Banking in Sintra and the ECB’s first Annual Research Conference. Other important conferences included the International Monetary Policy Research Forum, the 9th ECB Workshop on Forecasting Techniques and the 12th Competitiveness Research Network Conference.

Many of the ECB’s research activities also resulted in published papers. In total, 115 papers were published in the ECB’s Working Paper Series during 2016. In addition, 73 papers either authored or co-authored by ECB staff were published in refereed journals. This pool of high-quality research papers also provided the basis for an enhanced communication of research findings to a wider and more general public, for instance via the ECB Research Bulletin.

Legal activities and duties

In 2016 the ECB took part in several judicial proceedings at the EU level. The ECB also adopted numerous opinions in response to the Treaty-based requirement for the ECB to be consulted on any proposed EU act or draft national legislation falling within its fields of competence, as well as monitoring compliance with the prohibition of monetary financing and privileged access. Finally, the ECB adopted a number of legal acts and instruments in relation to its supervisory tasks.

ECB participation in judicial proceedings at the EU level

In September 2016 the Court of Justice of the European Union ruled on appeal in two sets of cases filed by some depositors in the Cypriot banks which were subject to the 2013 resolution measures. The applicants alleged that the relevant resolution measures were imposed by the ECB and the European Commission based on their involvement in the Eurogroup meetings and their role in the negotiation and adoption of the Cypriot Memorandum of Understanding (“Cypriot MoU”).

In the first set of cases^[94], the applicants sought the annulment of the Eurogroup statement of 25 March 2013 concerning Cyprus’ financial assistance programme and in particular the restructuring of its banking sector. The Court of Justice confirmed the General Court’s finding that the contested Eurogroup statement could not be regarded as a joint decision of the Commission and the ECB. The Court of Justice also observed that the adoption by the Cypriot authorities of the legal framework necessary for the restructuring of the banks could not be regarded as having been imposed by an alleged joint decision of the Commission and the ECB that was given concrete expression in the Eurogroup statement. The cases were therefore rejected as inadmissible.

In the second set of cases^[95], the applicants sought compensation for the losses allegedly suffered as a result of the inclusion in the Cypriot MoU of paragraphs referring to the resolution of the two Cypriot banks and/or the annulment of these disputed paragraphs. The Court of Justice quashed the General Court inadmissibility orders on the basis that the allegedly unlawful conduct of EU institutions, even in the legal framework of the Treaty establishing the European Stability Mechanism (“ESM Treaty”), may theoretically give rise to liability of the European Union under Article 340(2) and (3) of the Treaty on the Functioning of the European Union. This finding was based on the European Commission’s obligation under Article 17(1) of the Treaty on European Union to promote the general interest of the Union and oversee the application of Union law, and its obligation under Article 13(3) and (4) of the ESM Treaty to ensure that any MoU concluded by the ESM is consistent with EU law. The Court of Justice held on substance that, in view of an objective of general interest pursued by the European Union, namely the objective of ensuring the financial stability of the banking system in the euro area, the resolution measures identified in the Cypriot MoU did not constitute an intolerable and disproportionate interference with the right to property of the appellants. Accordingly, the European Commission could not be considered, by dint of having permitted the adoption of the disputed paragraph in the Cypriot MoU, to have contributed to a breach of the appellants’ right to property. The Court of Justice therefore dismissed the claims for compensation as lacking any foundation in law.

In July 2016 the General Court of the EU ruled in favour of the ECB in an annulment and damages case concerning certain ECB Governing Council decisions relating to the provision of emergency liquidity assistance (ELA) by the Bank of Greece to Greek banks. In Case T-368/15, the applicant alleged that the contested ELA decisions were unlawful and “inescapably resulted” in the temporary bank holidays and capital controls imposed by the Greek authorities in the summer of 2015, which in turn led to the applicant suffering “serious and irreparable damage”. With respect to the annulment claim, the General Court found that the requirement for the contested ELA decisions to be of direct concern to the applicant was manifestly not satisfied and therefore dismissed the claim as inadmissible. In particular, the General Court held that by maintaining the ELA ceiling, the contested decisions did not in any way impose the measures at issue (i.e. the capital controls), with the result that the Greek authorities were fully at liberty to take measures other than those measures. The General Court also dismissed the damages claim as inadmissible.

In May 2016 the General Court decided on the appeal submitted by 150 ECB staff members (case T-129/14 P) against the judgement of the Civil Service Tribunal in case F-15/10 concerning the ECB pension reform. In May 2009, following a reform process of about two years, the ECB froze the existing Retirement Plan, a hybrid system, and adopted a new Pension Scheme composed of a defined benefit scheme as a first pillar and a defined contribution scheme as a second pillar. Pension rights are accrued in the ECB Pension Scheme for periods of service from 1 June 2009, for all staff members, including those who had taken up employment prior to or on the date of entry into force of the reform, with only one exception applying to members of staff who were between 60 and 65 years of age on 31 May 2009 and remained covered by the ECB Retirement Plan in respect of their past and future service. The appeal brought by 150 members of staff criticised several points of the first instance judgement in eight pleas in law. In its appeal judgement, the General Court upheld the judgement of the Civil Service Tribunal, rejecting all eight pleas in their entirety, and thereby again fully confirming the legality of the ECB pension reform. As regards the procedure followed to implement the reform, the General Court considered that the ECB had not breached the principles of legality and legal certainty. It confirmed that changes to the pension rules had been decided in compliance with the rules on competence and procedure. Regarding the substantive issues, this judgement occasioned an in-depth analysis of the nature of pension rights. The General Court considered that pension rights are not part of the notion of “remuneration” within the meaning of Directive 91/533^[96]. Hence they are not an intangible element of the contract of employment, and the ECB is entitled to reform the retirement scheme without the consent of its staff. With regard to the acquired right invoked by the applicants to retire from the age of 60 with no reduction in benefits, the General Court recalled that it is settled case-law that an official cannot claim an acquired right unless the facts giving rise to that right arose prior to the amendment of the provisions. Moreover, the General Court considered that the acquired rights of members of staff who had reached the age of 60 when the reform entered into force were not affected by the reform given the transitional regime which the ECB had foreseen as part of the reform package.

ECB opinions and cases of non-compliance

Articles 127(4) and 282(5) of the Treaty on the Functioning of the European Union (the “Treaty”) require that the ECB be consulted on any proposed EU or draft national legislation falling within its fields of competence.^[97] 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 2016 the ECB adopted 8 opinions on proposed EU legislation and 53 opinions on draft national legislation falling within its field of competence.

At the EU level, the most significant opinions^[98] adopted by the ECB related to a European framework for simple, transparent and standardised securitisation and amendments to the Capital Requirements Regulation (CON/2016/11), the unified representation of the euro area in the International Monetary Fund (CON/2016/22) and the establishment of a European deposit insurance scheme (CON/2016/26).

A number of consultations by national authorities concerned legislation related to banknotes and coins^[99], the oversight of payment schemes^[100], the book-entry securities system^[101], mandatory requirements for credit transfers and direct debits^[102] and the prevention of money laundering and terrorist financing^[103].

The ECB adopted opinions concerning national central banks (NCBs), including the auditing requirements applicable to an NCB^[104], an NCB’s reporting obligations vis-à-vis the national parliament^[105], the functioning of an NCB’s decision-making body^[106], the reduction in the remuneration of senior officials of an NCB^[107], an NCB’s acquisition of ownership of an entity performing monetary policy operations in its outermost regions and overseas territories^[108], an NCB’s ELA operations^[109], an NCB’s resolution tasks^[110], an NCB’s role in relation to a deposit guarantee scheme^[111], NCBs’ supervision of the provision of payment services^[112], escrow institutions^[113] and consumer credit arrangements^[114], NCBs’ operation of central credit registers and registers of bank accounts^[115], an NCB’s collection of financial statistics^[116], the role of an NCB in assessing competition in the market for mortgage loans^[117], an NCB’s contribution to an IMF-administered trust^[118], the role of an NCB in reporting on an insurance premium levy^[119], the monetary policy instruments of non-euro area NCBs^[120], the exclusion of set-off rights with respect to claims mobilised as collateral with ESCB central banks^[121] and an NCB’s issuance of commemorative banknotes^[122].

The ECB adopted opinions on various aspects of the activities of financial institutions^[123], including the insolvency hierarchy of creditors of credit institutions^[124], the imposition of limits on variable rates on mortgage loans^[125], the remuneration of deposit savings accounts^[126], mortgage amortisation requirements^[127], the reimbursement of certain spreads charged on foreign exchange-linked loans^[128], restructuring foreign currency loans^[129], the reform of cooperative banks^[130], restrictions on the acquisition of real property or share capital by credit institutions^[131], the appointment of a bank’s supervisory board members^[132], payment-to-income and loan-to-value ratios^[133], a guarantee scheme for securitisations of non-performing loans^[134], the imposition of a tax on certain financial institutions^[135], the functioning of central credit registers^[136] and the functioning of national deposit guarantee schemes^[137].

The ECB also adopted an opinion on the role of a national financial supervisory authority’s representative on the ECB’s Supervisory Board^[138].

Eight cases of non-compliance with the obligation to consult the ECB on draft national legislation were recorded, with some cases being considered clear and important^[139].

The ECB was not consulted by the Italian Ministry of Economy and Finance on the Decree Law on urgent measures for the protection of savings in the banking sector, aimed at setting the legal framework for the provision of extraordinary public financial support to Italian banks. The ECB was not consulted by the Greek Ministry of Finance on the law on electronic payments.

Finally, the ECB was not consulted by the Hungarian Ministry for National Economy on the Law on the National Home Building Communities^[140], raising concerns about a possible breach of central bank independence.

The failures to consult the ECB by Greece, Hungary and Italy were considered to be clear and important and also repetitive cases.

Legal developments related to the Single Supervisory Mechanism

In 2016 the ECB adopted several legal instruments concerning the performance of its supervisory tasks which were published in the Official Journal of the European Union and on the ECB’s website. A list of the legal instruments concerning banking supervision that were adopted in 2016 can be found in the ECB Annual Report on supervisory activities 2016.

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 2016 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 not all EU NCBs in 2016 had remuneration policies for public sector deposits in place that fully complied with the remuneration ceilings. In particular, a few NCBs need to ensure that the remuneration rate for public sector deposits is not above the ceiling even when the latter is negative.

The ECB assessed the establishment and funding of MARK Zrt., an asset management company, by the Magyar Nemzeti Bank as constituting a violation of the monetary financing prohibition that needs to be corrected.

In May 2016, the Magyar Nemzeti Bank provided a three-month bridge liquidity facility to the Hungarian investor compensation scheme Karrendezesi Alap. The ECB assessed that this operation potentially conflicts with the monetary financing prohibition given that other options were available to provide short-term financing to the investor compensation scheme that would not have resulted in the financial involvement of the Magyar Nemzeti Bank. This case should not serve as a precedent.

Following up on the concerns raised in the ECB’s Annual Report of 2014 and 2015, the ECB has continued to monitor several programmes launched by the Magyar Nemzeti Bank in 2014 and 2015. These programmes were not related to monetary policy and potentially conflict with the monetary financing prohibition, to the extent that they could be viewed as the Magyar Nemzeti Bank taking over state tasks or otherwise conferring financial benefits on the state. The programmes included real estate investment purchases by the Magyar Nemzeti Bank, a programme to promote financial literacy run through a network of six foundations and the investment strategy of these foundations, the transfer to the central bank of staff formerly employed by the Hungarian Financial Supervisory Authority, a programme of purchases of Hungarian artworks and cultural properties, and a programme incentivising banks to purchase eligible securities, notably government bonds. In view of their multitude, scope and size, the ECB will continue to closely monitor these operations so as to ensure that there are no conflicts with the prohibition of monetary financing and of privileged access. The Magyar Nemzeti Bank should also ensure that the central bank resources that it conferred on its network of foundations are not used, directly or indirectly, for state financing purposes. 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 2016, mainly through sales of long-duration floating rate notes, is a step in the direction of the necessary full disposal of these assets. However, a more ambitious sales schedule would further mitigate the persisting serious monetary financing concerns.

International and European relations

European relations

In 2016 the ECB maintained its close dialogue with European institutions and fora, in particular with the European Parliament, the European Council, the ECOFIN Council, the Eurogroup and the European Commission. Further steps were taken in the course of the year to complete banking union and to continue the repair of the financial sector in the euro area. The economic situation in the euro area and the macroeconomic adjustment programme for Greece also featured on the agendas of Eurogroup and ECOFIN Council meetings, in which the President of the ECB and other members of its Executive Board took part. The need for a coherent strategy for fiscal, financial and structural policies to strengthen the recovery in Europe was a topic of discussion in European Council meetings, in which the President of the ECB participated.

Completing Europe’s Economic and Monetary Union

Further work on completing Economic and Monetary Union (EMU) was undertaken, in line with the roadmap set out in 2015 in the so-called Five Presidents’ report entitled “Completing Europe’s Economic and Monetary Union”.

Progress was made on the banking union by implementing the Bank Recovery and Resolution Directive and the Deposit Guarantee Scheme Directive. Throughout the year, the ECB also continued to advocate decisive steps to complete banking union, particularly in technical discussions aimed at creating a credible common backstop to the Single Resolution Fund and a European deposit insurance scheme. Alongside banking union, a European capital markets union has the potential to make the financial system more resilient by improving cross-border risk-sharing and fostering broader and easier access to finance.

As regards the economic governance framework, the European Fiscal Board became operational. Looking ahead, the mandate and institutional independence of the European Fiscal Board should be strengthened to ensure that it can play an important role in increasing transparency and improving compliance with the fiscal rules.^[141] On 20 September 2016 the EU Council issued a recommendation calling upon the euro area countries to establish national productivity boards. Productivity boards are expected to provide new impetus to the implementation of structural reforms in euro area countries. Their effectiveness will depend not only on the expected high level of technical expertise within the boards, but also on their full independence. The work of the productivity boards would need to ensure that the European dimension is sufficiently taken into account, by exchanging best practices among Member States and by emphasising the euro area dimension when assessing and addressing productivity issues at Member State level.

Moreover, the ECB has regularly underlined the need for the consistent and thorough application of the provisions of the current governance framework, where progress has been unsatisfactory so far. This is exemplified by the limited implementation of the European Commission’s country-specific recommendations (see also Section 1.6 of Chapter 1) and the lack of compliance with the requirements of the Stability and Growth Pact.

Full implementation of the budgetary rules and a more effective coordination of economic policies will be a prerequisite for creating the necessary trust among Member States to go ahead with EMU deepening. The ECB has emphasised the importance of greater shared sovereignty in the medium to long run, for example through enhanced governance by moving from a system of rules towards institutions^[142].

At the same time, Europe also faces challenges outside the economic sphere, notably in the realms of migration and security. A strong economy is needed to address these issues in a sustainable manner. Completing EMU is thus an important endeavour in making Europe stronger. The Eurosystem stands ready to support this work.

Discharging democratic accountability

The ECB is an independent institution which enjoys full independence in using its instruments as necessary within its mandate. Accountability is the necessary counterpart to that independence and the Treaty on the Functioning of the European Union provides that the ECB is primarily accountable to the European Parliament as the body composed of the elected representatives of the EU’s citizens.

In 2016 the President of the ECB attended four regular hearings of the Committee on Economic and Monetary Affairs of the European Parliament.^[143] At these hearings, Members of the European Parliament (MEPs) focused in particular on the ECB’s monetary policy, financial sector policies, macroeconomic adjustment programmes and the reform of euro area governance (see Chart 36).

In 2016 the ECB decided to publish for the first time its feedback on the input provided by the European Parliament as part of its resolution on the previous year’s Annual Report, in response to a suggestion made in the European Parliament resolution as a step to further enhance accountability.^[144] This feedback had previously only been given to MEPs together with the Annual Report.

The ECB also discharges its accountability obligations through regular reporting and by answering written questions from MEPs. In 2016 the President of the ECB received letters containing such questions, the replies to which have been published on the ECB’s website.^[145] Most of the questions focused on the implementation of the ECB’s non-standard monetary policy measures, the economic outlook and macroeconomic adjustment programmes.

As in the past, the ECB provided input into the discussions of the European Parliament and the EU Council on legislative proposals within its competency. Outside the accountability framework, other ECB representatives participated in public meetings before the Committee on Economic and Monetary Affairs for technical discussions on the issues related to the ECB’s areas of expertise and tasks.

The ECB is also held accountable for its banking supervision activities by both the European Parliament and the EU Council.^[146] More detailed information is provided in the 2016 ECB Annual Report on supervisory activities.

International relations

In a challenging international environment, the ECB participated in discussions in international fora, gathered information and communicated on its own policy, thus strengthening relations with key international counterparts. This was especially important in a year when monetary authorities across the globe continued to support the nascent economic recovery.

G20

Amid the continued sluggish global economic recovery, China’s G20 presidency focused on fostering global growth and succeeded in highlighting the role of structural reforms in complementing fiscal and monetary policy to achieve this goal. The G20 presidency moreover broadened the debate on the engines of growth to include innovation and digitalisation. The G20 also put in place further measures to allow a better peer review of structural reforms under its “enhanced structural reform agenda”. Against the background of rising anti-globalisation sentiment, the G20 focused more on inequality and inclusiveness and also encouraged progress towards a fairer global tax environment with a new focus on beneficial ownership and how to address uncooperative tax jurisdictions. The G20 finance ministers and central bank governors, whose meetings are attended by the President of the ECB, committed to consult closely on foreign exchange markets and to avoid any form of protectionism in trade and investment policies. Efforts to address terrorism financing have also been stepped up amid recent terrorist attacks. The finalisation of the core elements of the financial regulatory framework was supported, with an emphasis on a timely, full and consistent implementation of the agreed financial sector reform agenda. At the Hangzhou summit, G20 leaders also encouraged progress in terms of promoting green financing and, in the context of discussions on the international financial architecture, examining the broader use of special drawing rights (SDRs), broadening the membership of the Paris Club and promoting the role of the new and existing multilateral development banks.

Policy issues related to the IMF and the international financial architecture

The ECB continued to promote common European positions in discussions at the International Monetary Fund (IMF) on Fund policies and the international financial architecture more generally. In terms of IMF governance, the far-reaching 2010 quota and governance reform became effective in early 2016 following ratification by the required majorities of IMF members. This resulted in a shift of more than 6% of quota shares to dynamic emerging market and developing countries, better reflecting their increased role in the global economy. As part of this reform package, advanced European countries committed to reduce their combined Board representation by two chairs.

The ECB supports a strong, quota-based and adequately resourced IMF at the centre of the international monetary system, where it makes an important contribution to global economic and financial stability. With the backing of EU Member States, total IMF quota resources doubled to SDR 477 billion in 2016. The IMF membership, including a number of EU Member States, also committed around SDR 260 billion to ensure the Fund’s continued access to bilateral borrowing under a strengthened governance framework. The timeline for discussions on the Fifteenth General Review of Quotas was altered with the purpose of concluding the review no later than the Annual Meetings of 2019.

As it is vital that the IMF’s lending polices remain relevant to the needs of its membership, the IMF examined the adequacy of the global financial safety net, including its coverage, its availability and the costs of providing crisis prevention and resolution instruments.

Following crises in some euro area countries and related EU-IMF lending and adjustment programmes for those countries, the IMF’s Independent Evaluation Office (IEO) published a comprehensive report on the Fund’s role during these crises and its participation in financial assistance programmes for Greece, Ireland and Portugal. While the report largely focused on the IMF’s decision-making process, it also included some reflections on economic issues such as the causes of the crisis and the nature and appropriateness of policy conditions.

Technical cooperation

The ECB broadened its technical cooperation with central banks outside the European Union to foster sound central banking practices and thereby contribute to global monetary and financial stability. The cooperation activities reflect the ECB’s role as a major central bank in the global economy. The ECB continued to collaborate with central banks of G20 emerging market economies (e.g. India and Turkey) to share technical expertise and best practices. In 2016 a new Memorandum of Understanding was signed with the Banco Central do Brasil as a basis for intensified cooperation, focusing on core central banking topics including monetary policy, financial stability and banking supervision. Strengthened cooperation with international and regional organisations supported the ECB’s outreach in Latin America, Asia and Africa.

The ECB’s cooperation with central banks in countries that have a prospect of joining the European Union continued, mainly through a regional workshop series. Dedicated events focused on institutional challenges in the context of EU accession, macroprudential and microprudential supervision, and central bank independence as a key element of good economic governance. Technical cooperation with central banks of EU candidate and potential candidate countries is performed in close cooperation with EU NCBs and complements the ECB’s regular monitoring and analysis of economic and financial developments in these countries and the policy dialogue with their central banks.

External communication

Explaining the ECB’s policy to European citizens

Open and transparent communication supports the effectiveness of a central bank’s policy. It allows the bank to keep the general public and financial markets informed about its objectives and tasks, explain the reasons for its actions and thereby guide their expectations. The ECB has a long tradition of open communication and in 2016 continued to enhance its communication, in particular by further developing its outreach activities and digital communication.

Outreach activities

In 2016 the ECB further developed its initiatives to reach out to the general public to improve understanding of the ECB’s policies and decisions and, in this way, to build greater trust among euro area citizens.

The ECB welcomed 522 visitor groups in Frankfurt, hosting more than 15,000 external visitors from 35 countries. Visitors were offered general presentations as well as targeted presentations allowing for interaction with ECB experts. They were also able to explore the new ECB building and its art and euro exhibitions in guided tours. In July 2016 the ECB also started opening its doors on the first Saturday of every month to the local community, attracting more than 3,000 visitors in the second half of the year.

To explain its tasks to younger citizens of the euro area, the ECB held its Generation €uro Students’ Award competition for the sixth time. The competition is the Bank’s primary interaction channel with students aged between 16 and 19 and their teachers, and aims to teach them more about monetary policy and the ECB. The students participate in a role play in which they take monetary policy decisions on the basis of their diagnosis of the economic and monetary situation in the euro area.

The ECB also focused on younger age groups. On 3 October 2016, 230 children aged between eight and ten, together with their families, were welcomed to the ECB for the second open day of the popular German children’s TV show “Die Sendung mit der Maus”. The programme included guided tours of the building, presentations, workshops on the role and function of the ECB and the euro banknotes and coins, educational games and several exhibitions.

Outreach efforts were also conducted outside Frankfurt. For example, the ECB, together with the Central Bank of Ireland, attended Ireland’s National Ploughing Championships 2016, the largest outdoor exhibition and agricultural trade show in Europe.

Greater digitalisation

The ECB has also further increased its digital communication efforts in order to adapt to current news consumption patterns.

From a content perspective, the ECB has stepped up efforts to be more accessible to the general public, making its decisions better understood by using plain language and digital communication channels to explain otherwise rather technical concepts. One example of this are the explainers on the ECB’s website, which are available in many EU languages. A more intensive use of infographics has also accompanied this digital focus.

From a technical perspective, the Bank further modernised its websites. The websites of both the ECB and the European Systemic Risk Board have been made fully responsive, ensuring that web pages and important publications can be viewed in an optimal way regardless of the device which readers choose. In addition, the ECB has met the increased demand for high-quality web streaming of events.

The Bank’s presence on social media platforms has increased further. The ECB’s Twitter account now counts more than 360,000 followers and is used to highlight publications and key messages from speeches. In December 2016 the ECB held its first live debate on Twitter, during which Benoît Cœuré answered questions posted by the general public under #askECB, thereby allowing for direct interaction in real time. Furthermore, the ECB uses its YouTube channel to publish video content and Flickr for photographs. The ECB also holds a LinkedIn account to which some 43,000 citizens have subscribed.

Annexes

Institutional framework

Decision-making bodies and corporate governance of the ECB

The Eurosystem and the European System of Central Banks (ESCB) are governed by the decision-making bodies of the ECB: the Governing Council and the Executive Board. The General Council is constituted as a third decision-making body of the ECB for as long as there are EU Member States which have not yet adopted the euro. The functioning of the decision-making bodies is governed by the Treaty on the Functioning of the European Union, the Statute of the ESCB and the relevant Rules of Procedure.^[149] Decision-making within the Eurosystem and the ESCB is centralised. However, the ECB and the euro area national central banks (NCBs) jointly contribute, strategically and operationally, to attaining the common goals of the Eurosystem, with due respect to the principle of decentralisation in accordance with the Statute of the ESCB.

In the context of the ECB’s responsibilities related to banking supervision, the Governing Council adopts legal acts establishing the general framework within which supervisory decisions are taken and approves, under the non-objection procedure, draft supervisory decisions prepared by the Supervisory Board.^[150] More detailed information on the ECB’s supervisory function can be found in the ECB Annual Report on supervisory activities 2016.

The Governing Council

The Governing Council is the main decision-making body of the ECB. It comprises the members of the Executive Board of the ECB and the governors of the NCBs of the euro area countries. The voting rights of the members of the Governing Council rotate according to a specific scheme that is available on the ECB’s website.

The Governing Council usually meets every two weeks at the ECB’s premises in Frankfurt am Main, Germany. In 2016 a total of 23 meetings took place. Meetings dedicated to monetary policy are held every six weeks. An account of these monetary policy meetings is published, generally with a four-week time lag. At the non-monetary policy meetings, the Governing Council mainly discusses issues related to other tasks and responsibilities of the ECB and the Eurosystem. To ensure the separation of the ECB’s monetary policy and other tasks from its supervisory responsibilities, separate meetings of the Governing Council are held for supervisory issues.

The Governing Council can also take decisions by means of a written procedure. In 2016 more than 1,400 written procedures were conducted, of which more than 1,000 were non-objection procedures.

The Governing Council

Mario Draghi President of the ECB

Vítor Constâncio Vice-President of the ECB

Josef Bonnici Governor of the Central Bank of Malta (until 30 June 2016)

Benoît Cœuré Member of the Executive Board of the ECB

Carlos Costa Governor of the Banco de Portugal

Chrystalla Georghadji Governor of the Central Bank of Cyprus

Ardo Hansson Governor of Eesti Pank

Boštjan Jazbec Governor of Banka Slovenije

Klaas Knot President of De Nederlandsche Bank

Philip R. Lane Governor of the Central Bank of Ireland

Sabine Lautenschläger Member of the Executive Board of the ECB

Erkki Liikanen Governor of Suomen Pankki – Finlands Bank

Luis M. Linde Governor of the Banco de España

Jozef Makúch Governor of Národná banka Slovenska

Yves Mersch Member of the Executive Board of the ECB

Ewald Nowotny Governor of the Oesterreichische Nationalbank

Peter Praet Member of the Executive Board of the ECB

Gaston Reinesch Governor of the Banque centrale du Luxembourg

Ilmārs Rimšēvičs Governor of Latvijas Banka

Jan Smets Governor of the Nationale Bank van België/

Banque Nationale de Belgique

Yannis Stournaras Governor of the Bank of Greece

Vitas Vasiliauskas Chairman of the Board of Lietuvos bankas

Mario Vella Governor of the Central Bank of Malta (from 1 July 2016)

François Villeroy de Galhau Governor of the Banque de France

Ignazio Visco Governor of the Banca d’Italia

Jens Weidmann President of the Deutsche Bundesbank

Front row (from left to right): Yannis Stournaras, Carlos Costa, Ewald Nowotny, Vítor Constâncio, Mario Draghi, Sabine Lautenschläger, Benoît Cœuré, Chrystalla Georghadji, Philip R. Lane, Yves Mersch

Middle row (from left to right): Ilmārs Rimšēvičs, François Villeroy de Galhau, Jens Weidmann, Erkki Liikanen, Jozef Makúch, Ignazio Visco

Back row (from left to right): Gaston Reinesch, Boštjan Jazbec, Ardo Hansson, Klaas Knot, Jan Smets, Peter Praet, Vitas Vasiliauskas

Note: Luis M. Linde and Mario Vella were not available at the time the photograph was taken.

The Executive Board

The Executive Board comprises the President and the Vice-President of the ECB and four other members appointed by the European Council, acting by qualified majority, after consultation with the European Parliament and the ECB. The Executive Board is responsible for the preparation of Governing Council meetings, the implementation of monetary policy for the euro area in accordance with the guidelines specified and decisions taken by the Governing Council, and the management of the day-to-day business of the ECB.

The Executive Board

Mario Draghi President of the ECB

Vítor Constâncio Vice-President of the ECB

Benoît Cœuré Member of the Executive Board of the ECB

Sabine Lautenschläger Member of the Executive Board of the ECB

Yves Mersch Member of the Executive Board of the ECB

Peter Praet Member of the Executive Board of the ECB

Front row (left to right): Sabine Lautenschläger, Mario Draghi, Vítor Constâncio

Back row (left to right): Yves Mersch, Peter Praet, Benoît Cœuré

The General Council

The General Council is composed of the President and the Vice-President of the ECB and the governors of the NCBs of all 28 EU Member States. Among other things, the General Council contributes to the ECB’s advisory functions, the collection of statistical information, the establishment of the necessary rules for standardising the accounting and reporting of operations undertaken by the NCBs, the taking of measures relating to the establishment of the key for the ECB’s capital subscription other than those laid down in the Treaty, and the laying-down of the conditions of employment of the members of staff of the ECB.

The General Council

Mario Draghi President of the ECB

Vítor Constâncio Vice-President of the ECB

Marek Belka President of Narodowy Bank Polski (until 20 June 2016)

Josef Bonnici Governor of the Central Bank of Malta (until 30 June 2016)

Mark Carney Governor of the Bank of England

Carlos Costa Governor of the Banco de Portugal

Chrystalla Georghadji Governor of the Central Bank of Cyprus

Adam Glapiński President of Narodowy Bank Polski (from 21 June 2016)

Ardo Hansson Governor of Eesti Pank

Stefan Ingves Governor of Sveriges Riksbank

Mugur Constantin Isărescu Governor of Banca Naţională a României

Boštjan Jazbec Governor of Banka Slovenije

Klaas Knot President of De Nederlandsche Bank

Philip R. Lane Governor of the Central Bank of Ireland

Erkki Liikanen Governor of Suomen Pankki – Finlands Bank

Luis M. Linde Governor of the Banco de España

Jozef Makúch Governor of Národná banka Slovenska

György Matolcsy Governor of the Magyar Nemzeti Bank

Ewald Nowotny Governor of the Oesterreichische Nationalbank

Dimitar Radev Governor of Българска народна банка (Bulgarian National Bank)

Gaston Reinesch Governor of the Banque centrale du Luxembourg

Ilmārs Rimšēvičs Governor of Latvijas Banka

Lars Rohde Governor of Danmarks Nationalbank

Jiří Rusnok Governor of Česká národní banka (from 1 July 2016)

Miroslav Singer Governor of Česká národní banka (until 30 June 2016)

Jan Smets Governor of the Nationale Bank van België/

Banque Nationale de Belgique

Yannis Stournaras Governor of the Bank of Greece

Vitas Vasiliauskas Chairman of the Board of Lietuvos bankas

Mario Vella Governor of the Central Bank of Malta (from 1 July 2016)

François Villeroy de Galhau Governor of the Banque de France

Ignazio Visco Governor of the Banca d’Italia

Boris Vujčić Governor of Hrvatska narodna banka

Jens Weidmann President of the Deutsche Bundesbank

Front row (left to right): Yannis Stournaras, Carlos Costa, Ewald Nowotny, Vítor Constâncio, Mario Draghi, Mark Carney, Chrystalla Georghadji, Philip R. Lane

Middle row (left to right): Ilmārs Rimšēvičs, François Villeroy de Galhau, Jens Weidmann, Erkki Liikanen, Ignazio Visco

Back row (left to right): Gaston Reinesch, Boštjan Jazbec, Lars Rohde, Ardo Hansson, Klaas Knot, Jan Smets, Jozef Makúch, Vitas Vasiliauskas, Dimitar Radev

Note: Adam Glapiński, Stefan Ingves, Mugur Constantin Isărescu, Luis M. Linde, György Matolcsy, Jiří Rusnok, Boris Vujčić and Mario Vella were not available at the time the photograph was taken.

Corporate governance

In addition to the decision-making bodies, the corporate governance structure of the ECB encompasses two high-level committees – the Audit Committee and the Ethics Committee – and a number of other external and internal control layers. It is complemented by the Ethics Framework, the ECB Decision^[151] providing the terms and conditions for anti-fraud investigations, and the rules concerning public access to ECB documents. Following the establishment of the Single Supervisory Mechanism (SSM), corporate governance issues have gained even more significance for the ECB.

Audit Committee

The ECB Audit Committee supports the Governing Council by providing advice and opinions in respect of (i) the integrity of financial information, (ii) the oversight of internal controls, (iii) compliance with applicable laws, regulations and codes of conduct, and (iv) the performance of the audit functions. Its mandate is available on the ECB’s website. The Audit Committee is chaired by Erkki Liikanen and in 2016 included four other members: Vítor Constâncio, Josef Bonnici^[152], Patrick Honohan and Ewald Nowotny.

Ethics Committee

In order to ensure the adequate and coherent implementation of the various codes of conduct of the bodies involved in the ECB’s decision-making processes, the Ethics Committee provides advice and guidance on questions of ethics to the members of the Governing Council, the Executive Board and the Supervisory Board. Its mandate is available on the ECB’s website. The Ethics Committee is chaired by Jean-Claude Trichet and includes two other external members: Patrick Honohan^[153] and Klaus Liebscher.

External and internal control layers

External control layers

The Statute of the ESCB provides for two external control layers, namely the external auditor, appointed on a rotating basis for a five-year term to audit the annual accounts of the ECB, and the European Court of Auditors, which examines the operational efficiency of the management of the ECB.

Internal control layers

A three-tier system of internal controls has been established at the ECB consisting of (i) management controls, (ii) various risk and compliance oversight functions, and (iii) independent audit assurance.

The internal control structure of the ECB is based on a functional approach in which each organisational unit (section, division, directorate or directorate general) has primary responsibility for managing its own risks, as well as for ensuring the effectiveness and efficiency of its operations.

Oversight functions comprise monitoring mechanisms and effective processes to achieve adequate control of financial and operational risks as well as reputational and conduct risks. These second-level control functions are performed by internal ECB functions (such as the budget and controlling function, the operational and financial risk management functions, the quality assurance function for banking supervision or the compliance function) and/or – as relevant – by Eurosystem/ESCB committees (e.g. the Organisational Development Committee, the Risk Management Committee or the Budget Committee).

In addition, and independently from the internal control structure and risk monitoring of the ECB, audit missions are performed by the ECB’s internal audit function under the direct responsibility of the Executive Board, in accordance with the ECB Audit Charter. The ECB’s internal audit activities conform to the International Standards for the Professional Practice of Internal Auditing of the Institute of Internal Auditors. Furthermore, the Internal Auditors Committee, which is composed of internal audit experts from the ECB, the NCBs and the national competent authorities, assists the Eurosystem/ESCB and the SSM in accomplishing their objectives.

ECB Ethics Framework

The ECB Ethics Framework consists of the Code of Conduct for the members of the Governing Council, the Supplementary Code of Ethics Criteria for the members of the Executive Board, the Code of Conduct for the members of the Supervisory Board and the ECB Staff Rules. The Ethics Framework establishes ethical rules and guiding principles to ensure that the highest levels of integrity, competence, efficiency and transparency are met in the performance of ECB tasks. It includes, among other things, detailed provisions governing the avoidance and management of potential conflicts of interest; restrictions, reporting obligations and a monitoring scheme concerning private financial transactions; cooling-off rules concerning subsequent occupational activities; and detailed rules concerning external activities and relations with external parties.

Anti-fraud/anti-money laundering measures

In 1999 the European Parliament and the EU Council adopted a Regulation^[154] to allow, among other things, internal investigations by the European Anti-Fraud Office (OLAF) of suspected fraud within EU institutions, bodies, offices and agencies. The legal framework covering the terms and conditions for investigations by OLAF of the ECB in relation to the prevention of fraud, corruption and any other illegal activities was endorsed by the Governing Council in 2004 and revised in 2016.^[155] Furthermore, in 2007 the ECB established its internal anti-money laundering (AML) and counter-terrorist financing (CTF) schemes. An internal reporting system complements the ECB’s AML/CTF framework to ensure that all relevant information is systematically collected and duly communicated to the Executive Board.

Access to ECB documents

The ECB’s Decision on public access to ECB documents^[156] is in line with the objectives and standards applied by other EU institutions and bodies with regard to public access to their documents. It enhances transparency, while at the same time taking into account the independence of the ECB and of the NCBs and ensuring the confidentiality of certain matters specific to the performance of the ECB’s tasks. Owing to the ECB’s new responsibilities in the field of banking supervision, the number and complexity of requests from citizens and national authorities for access to documents have increased substantially.

In February 2016, as part of its commitment to transparency and accountability, the ECB began publishing the meeting calendars of each of the Executive Board members and of the Chair of the Supervisory Board with a three-month lag.

Compliance and Governance Office

Reporting directly to the President of the ECB, the Compliance and Governance Office (CGO) supports the Executive Board in protecting the integrity and reputation of the ECB, promotes ethical standards of behaviour and strengthens the ECB’s accountability and transparency. To enhance both the overall coherence and the effectiveness of the ECB corporate governance framework, the CGO moreover provides the secretariat to the ECB Audit and Ethics Committees and acts as the liaison point for the European Ombudsman and OLAF.

Eurosystem/ESCB committees

The Eurosystem/ESCB committees have continued to play an important role in assisting the ECB’s decision-making bodies in the performance of their tasks. At the request of both the Governing Council and the Executive Board, the committees have provided expertise in their fields of competence and have facilitated the decision-making process. Membership of the committees is usually restricted to staff of the Eurosystem central banks. However, the NCBs of the Member States which have not yet adopted the euro take part in the meetings of a committee whenever it deals with matters that fall within the field of competence of the General Council. In addition, some of the committees meet in an SSM composition (i.e. one member from the central bank and one member from the national competent authority of each participating Member State) when they assist the ECB in its work on policy issues related to the prudential supervision of credit institutions. Representatives of other competent bodies may also be invited to committee meetings whenever it is deemed appropriate.

Two further committees exist. The Budget Committee assists the Governing Council in matters related to the ECB’s budget. The Human Resources Conference is a forum for the exchange of experience, expertise and information among Eurosystem/ESCB central banks in the field of human resources management.

Organisational and human resources developments

ECB human resources

A Chief Services Officer (CSO) was appointed in January 2016. This new role was created to further strengthen operational and analytical excellence, to improve organisational efficiency and to better facilitate the collaboration and orientation of support functions towards the needs of the ECB overall. Furthermore, the CSO, whose responsibilities include the administration and information systems areas, prioritised the development of a more holistic strategic planning process, further fostering collaboration across the CSO business areas and all other business areas.

The creation of a new business area in charge of all finance-related matters in April 2016 enabled the restructured human resources (HR) function to focus fully on delivering high-quality HR services, so that ECB employees can develop their potential within a modern and agile organisational structure. Attracting and retaining talented staff and managing their performance is a priority. In addition, the ECB’s HR services place particular emphasis on ensuring the health and well-being of ECB staff.

During 2016 the foundations were laid for enhancing the strategic Business Partner function to strengthen the ECB’s management of people issues, as well as for translating business requirements into HR policy needs.

Strengthening the Bank’s capabilities to manage talent and develop leadership and fostering a culture of excellence in terms of professional ethics and long-term organisational sustainability were also high on the ECB’s HR agenda in 2016. A particular focus was placed on the development of a Leadership Growth Programme, which will be implemented gradually in the course of 2017 and 2018, the implementation of a “healthy leading” programme, and support for the ECB’s recently established Compliance and Governance Office in developing compulsory training on ethics.

In addition, a number of HR initiatives aimed at strengthening the European banking supervision function were implemented. These included the further strategic development of a system-wide Single Supervisory Mechanism curriculum for supervision training (attended by over 1,900 participants), the organisation of 28 team-building events to reinforce cross-country collaboration in Joint Supervisory Teams and the successful integration of the first cohort of 33 young graduates selected for the European banking supervision traineeship programme, who have successfully completed their induction, training course and placements at national competent authorities.

In 2016 the ECB continued its efforts to enhance gender diversity especially among its leadership ranks. Having achieved a share of 27% of women in management-level positions and 18% of women in senior management-level positions at the end of 2016, the ECB is now striving to achieve its interim and final targets for 2017 and 2019 respectively (see Figure 3). Since the introduction of the gender targets in June 2013, alongside a dedicated action plan, the topic of gender diversity has been high on the ECB’s agenda as the organisation aims to identify, attract and develop female talent. In addition, the ECB implemented further diversity measures in 2016, including high-level sponsorship from Executive Board member Benoît Cœuré and the CSO, an open day for female talent focusing on university students, and the establishment of an ESCB and SSM Diversity Network.

Beyond gender, the ECB is committed to fostering all facets of diversity in order to establish an inclusive working culture building on shared responsibility among the sponsors, the ECB’s Diversity Ambassadors, the Directorate General Human Resources, the wider management community and the existing diversity networks, such as the Female Network, the Rainbow Network and the ECB Ethnic and Cultural Group.

On 31 December 2016 the ECB had 2,898.5 full-time equivalent approved headcount positions, compared with 2,650 positions at the end of 2015. The number of actual full-time equivalent staff holding employment contracts with the ECB stood at 3,171 (compared with 2,871 on 31 December 2015).^[157] A total of 208 new fixed-term contracts (limited in nature or convertible to permanent contracts) were offered in 2016. In addition, 304 short-term contracts were issued, as well as a number of contract extensions, to cover absences of less than one year. Throughout 2016 the ECB continued to offer short-term contracts for periods of up to 36 months to staff from NCBs and international organisations. On 31 December 2016 250 employees from NCBs and international organisations were working at the ECB on various assignments, 11% more than at the end of 2015. In September 2016 the ECB welcomed 14 participants in the 11th intake into its Graduate Programme and, on 31 December 2016, 320 trainees were being hosted by the ECB (17% more than in 2015). The ECB also awarded five fellowships as part of the Wim Duisenberg Research Fellowship Programme, which is open to leading economists, and six fellowships to young researchers under its Lamfalussy Fellowship Programme.

While the organisation grew slightly in size, 56 members of staff employed on a fixed-term or permanent basis resigned or retired in 2016 (compared with 53 in 2015), and 317 short-term contracts expired in the course of the year.

Annual Accounts

http://www.ecb.europa.eu/pub/pdf/annrep/ar2016annualaccounts_en.pdf

Consolidated balance sheet of the Eurosystem as at 31 December 2016

http://www.ecb.europa.eu/pub/pdf/other/eurosystembalancesheet2016.en.pdf

Statistical section

https://www.ecb.europa.eu/pub/pdf/annrep/ar2016/EN_AR16_STATISTICAL_ANNEX.pdf

Abbreviations

Countries

In accordance with EU practice, the EU Member States are listed in this report using the alphabetical order of the country names in the national languages.

Others

Conventions used in the tables

“-” data do not exist/data are not applicable

“.” data are not yet available