Rising debt, non-bank finance may limit ECB policy flexibility, says Schnabel

Rising public debt and the rapid expansion of non-bank financial institutions could limit the European Central Bank's ability to set appropriate monetary policy, ECB board member Isabel Schnabel said on Thursday. She warned that growing financial vulnerabilities may complicate efforts to control inflation, Reuters reported.

The ECB is currently raising interest rates to tackle excessive inflation, raising concerns that higher borrowing costs could make government finances increasingly difficult to sustain. The risks are particularly pronounced in highly indebted countries such as France, where rising debt-servicing costs could heighten fears of financial instability.

Schnabel said public debt had expanded significantly since the beginning of the century, with a growing share held by non-bank financial institutions, including hedge funds that may operate with substantial leverage.


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According to Reuters, this shift has made monetary policy transmission faster, potentially amplifying market volatility. Sharp movements in interest rates could reduce the value of bonds used as collateral, triggering higher margin requirements and forcing leveraged investors to sell assets.

Schnabel warned that such market stress could compel central banks to intervene to prevent liquidity problems from escalating into broader credit crises. However, these interventions could interfere with central banks' mandates and undermine monetary policy independence.

She called on European policymakers to avoid easing banking regulations and instead strengthen oversight of non-bank financial institutions, including hedge funds, investment funds and insurers.

Stronger regulation of non-bank institutions could also strengthen the case for granting them access to central bank facilities, providing an additional safeguard against systemic financial instability, Schnabel said.

The ECB board member, who is set to leave the central bank in January for a senior position at the International Monetary Fund (IMF), also highlighted the challenges posed by deteriorating public finances.

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Reuters reported that Schnabel noted the effective interest rate governments pay on their debt now exceeds economic growth, making it increasingly difficult to stabilise debt levels.

She said the situation reinforced the need for Europe to pursue long-discussed institutional reforms aimed at reversing the decline in potential economic growth and strengthening the region's long-term economic prospects.

(Disclaimer: This article is based on inputs from agencies. These do not represent the views of The Economic Times)