Transcript of Governor Gabriel Makhlouf's interview with Niall Brady, The Sunday Times

15 July 2022 Interview

Governor Gabriel Makhlouf

Interview with Governor Makhlouf conducted 16 June 2022

Niall Brady: Okay, well listen thanks again for taking the time to talk to me.  You had a very busy week, from what I see yesterday was a busy day for you. 

Gabriel Makhlouf: I’ve had a busy fortnight. 

Niall Brady: Really?  Why a busy fortnight

Gabriel Makhlouf: I mean this week’s been busy.  But last week I was at the governing council meeting, one of our regular monetary policy meetings. One where they actually do projections and there are new macroeconomic projections, they’re always pretty intensive because there’s loads of material to absorb and there’s always pretty long discussions. 

Niall Brady: And then yesterday’s meeting, how much advance notice did you get of that or how did that…?

Gabriel Makhlouf: Well, to be honest, my office told me the day before.  But I don’t know when my office knew. On one level, I wasn’t that surprised about it because ever since we’ve had WebEx and Zoom, we’ve had many more ad hoc meetings organised relatively late, because you can. Whereas in the old days, people would have to….anyway, that was the rough timescale. 

Niall Brady: I imagine though because of what you’re discussing they can’t be that ad hoc, the meetings though.  For some of these there is a large amount of prep to be done beforehand. Gabriel Makhlouf: I agree, but if you’re coming together to discuss an issue that you have already been talking about, there’s not a lot of prep that’s needed really.  And the topic that we were talking about yesterday is one that we off and on have been talking about now for a while.  So, at one level we didn’t need a lot of prep for it. 

Niall Brady: Just reading the coverage, it’s kind of brings you right back to a decade ago and the Euro crisis and the bond yields and the peripheral. I suppose the only difference this time is what Ireland, maybe the pigs only has one eye this time, we hope, you know. 

Gabriel Makhlouf: The difference between today and a year ago is enormous. A decade ago was essentially an unknown scenario and we’ve learned from where we were a decade ago.  So, you know, having a discussion about what’s happening in markets and what’s happening… let’s use the word fragmentation.  I mean that you know, we’re familiar with the issue.  So, that’s the biggest difference.  I mean of course, the European Union itself, not just the Central Bank, has been aware of that issue and has put in place an infrastructure to manage that issue… well, compared to where it was a decade ago. 

Niall Brady: But the design flaws in monetary union that led to the crisis…

Gabriel Makhlouf: You call it flaws but other people quite rightly tell you well this is by design.  We created a macroeconomic framework that by design is fragmented.  So, we have a monetary unit but we don’t have a fiscal policy and that creates pressures.  And the kind of pressures were pretty obvious a decade ago and some of them were addressed. The pandemic helped some things, added some things to it, so the next generation EU funding and collective funding that was agreed at EU level including the conditionality that that sort of funding has. I mean that’s helped to move things on.  But at the end of the day, we are dealing with a single monetary union and at one level, 19 different bond markets.  So, some people would call it a flaw and some people will say well actually, that’s how we set it up. 

Niall Brady: Okay. Just the review yesterday seems to be… you seem to be fairly sanguine about the Irish Exchequer and the Irish sovereign debt and our position that we don’t seem to be in with the troubled creditor economies, at least not yet. 

Gabriel Makhlouf: I mean compared to where we were, we’re in a much better position. And the strategy we have been following has been, from my perspective, in the right direction because it’s moving towards having a budget surplus next year.  And the medium-term outlook, from the last set of proposals from the government were sustainable.  The key thing is to keep on that track, not to get distracted from it and this is a point I made yesterday. The Central Bank spent a long time managing risk and the State itself needs to manage risk.  And it needs to think about what are the potential risks to its fiscal position.  And we know because we’ve been saying this for a while, at the end of the day, you’re at the limits of where you really want to be in terms of debt sustainability.  But in particular, you’ve got this vulnerability to the fluctuations of corporation tax rates which at the moment have been… surprises on the upside…but we know a lot of that tax is paid by a relatively small number of businesses who could make decisions.  I mean you know; they haven’t indicated any intention to leave Ireland.  They’ve indicated the opposite actually; they’ve indicated a lot of confidence in the Irish economy.  But on the other hand, relying on a small number of players, but a significant amount of players is a vulnerability which you need to manage for.  And as I said yesterday, I do think that the State should be thinking carefully about some sort of rainy-day fund.  I think it probably would be a mistake to conclude that this money, all of this money is a permanent source of funding, permanent additional funding, and we should now plan to spend it forever.  That would be risky. 

Niall Brady: Another point you made in the report was just on the supports, the government supports to help with the rising cost of living and that they need to be better targeted. That’s, in some ways I suppose that’s easy advice.  It could be very difficult to design supports, to target supports because of the risk of the… you’ll always have borderline cases which you just exclude now because they don’t meet the criteria or…

Gabriel Makhlouf: I suppose you’re right, in principle.  Then the question is, is the answer to then think about how you’re going to deal with borderline cases or is the answer to just give up on having something that’s targeted. That’s the question.  And in my view, having something that’s targeted means you will be getting more value for your euro, than you can probably help people more than by giving it to everyone. 

Niall Brady: Just on the interest rate increases that are sort of well flagged at this stage.  You yourself in recent speeches have said you know, interest rate, it’s not an estimate for dealing with inflation that’s caused by supply-side issues.  And I’m just wondering like what we’re seeing now, a lot of it would appear to be supply side issues. 

Gabriel Makhlouf: A lot of it, but not all of it. And certainly, energy is quite a big component of the shock. But with the evidence we’re seeing at the Governing Council is that inflation is becoming more broad-based. I think I said this yesterday, in particular that inflation expectations were beginning to not so much de-anchor, but the risk of it happening has increased. So, the balance… for me, and every Governing Council member will have that slightly different view.  For me, certainly I was arguing back in… I can’t remember, November or whenever it was, anyway at the end of last year, that we should exercise patience, that we should exercise vigilance and we should retain optionality and flexibility.  But my view now is that actually the facts have started to change, that there is a risk that people’s views on our determination to deliver our 2% target, that people’s views were… I mean to use the phrase, a word that we use, would be de-anchored because expectations are where we would be… what you might call the terminal rate and people are expecting us to be above 2% in the horizon and that is not what we’re aiming for.  So, that’s one of the drivers for action.  But we do have to do it because monetary policy is not the perfect time to fix everything in these circumstances.  We’ve got to do it in a way that’s predictable and gradual.  And we’ve got to retain optionality, to change the direction we’re going if the facts start to change.  So, I’ve been a bit reluctant to get into a position where we’re giving very concrete forward guidance as to what we’re going to do amidst all of this uncertainty.  But I think the nature of inflation that we’ve been seeing in the Euro area changed, it has changed from where it was last year.  I mean the risk of it becoming more embedded. It’s beginning to look like different enough to being purely a supply shock and the response to a supply shock.  That it required action on our part.  But we’re still running a very accommodative monetary policy. I was saying to someone earlier today… what we are now seeing last week was we’re moving into our main rate from -0.5% to -0.25%. I mean I know we’re moving but we’re still very low. 

Niall Brady: I’d like to come back to a question I asked you yesterday on the whole property funds issue because this has obviously been the first issue you raised when you moved to Ireland. 

Gabriel Makhlouf: So, you’ve read some of the stuff what I said, if you remember me talking about it. 

Niall Brady: No, I do, it’s… I find it very interesting myself.  Again, the report yesterday talked about you know, the office market in particular and all the new accommodation coming on stream.  I just passed it on the way down here, it’s incredible what’s happening. And it’s coming on stream and you talk about the risks or the near-term risk of what we’re supplying the office market.  Some of these funds are very highly leveraged and now they’re going to face a less accommodating interest rate environment.  Is now the time to start reducing liquidity in those funds?

Gabriel Makhlouf: Well, my quick answer to this is yes. Just leaving the funds aside for a minute, you want your macroprudential buffers to be operating and all the monetary conditions, and if you think about what happened two years ago in March 2020, we had very low rates but the shock of the pandemic resulted in this dash for cash. And the only reason frankly, in my view, that we didn’t have a bigger problem…I heard some narratives saying that the industry is so much more robust…it wasn’t because, the Fed stepped in initially and put in place a facility that acted as a massive backstop.  You know, okay, we then introduced at the ECB our own, but what March 2020 then showed, is actually what I said in first starting the job was and it sort of validated my concerns. The size of the sector is huge and it’s growing.  And it’s growing partly because we spent the last decade, globally, including Ireland and globally, fixing the problems that the banks created by developing this whole macroprudential framework.  As a result, a lot of money then went into non-banks and we are now faced with a situation in certain…as I said I felt, my views were confirmed in March, that the sector has got so big that actually there are risks to financial stability, not just investor protection, which has been a big focus of all official regulatory and supervisory work that’s being invested in the protection of those funds. Almost the fundamental basis of the industry has changed. And we focus on property funds because for us in Ireland, that’s the biggest link to the domestic economy.  Now there is a whole debate and discussion going on in the international regulatory community and the Financial Stability Board. But we just focussed on property funds. So, funds have got to be a in a position, because of their spec, that they’re robust in whatever monetary policy environment you’re operating in.  So, I think that’s the fundamental thing. Now the transition from where we are to where we might want to go is one, in the view of everything else that’s going on right now, is one of the things we’re thinking about as we come to the final outcome from the proposals. I think it’s important to think of it in that order.  What are the first principle things that we’re trying to do here?  And then secondly, what’s the transition path to get there and that’s where we’re going to make a lot of adjustment, and view of where we are.  I mean in short, the fact that monetary policy is normalising…in my view, it’s been normalising in the Euro area anyway since December.  The fact that it’s normalising does not mean you don’t need macroprudential tools. 

Niall Brady: Have you got much backlash on the consultation you’ve been doing on that?

Gabriel Makhlouf: We’ve had lots of feedback. Some of it is specific, some of it is. I think there are still people who don’t understand why we need a macroprudential framework.  And which is why when I spoke at the Irish Funds event a fortnight ago, I spent a bit of time trying to explain in my speech why we need them. But we had some of that feedback. Backlash is the wrong word to use to be honest. I mean I think we welcome all feedback because it helps us to understand the nature of our proposals. We’re giving it you know, serious thought.  We may do something a bit different to what we decided…but the analysis is ongoing.

Niall Brady: I suppose another thing that I find interesting about you is you looked at the whole issue of, obviously the capital, the bank capital was a big issue.  But also, the whole issue, the risk weighted capital. There was a very interesting graph in there comparing you know, risk weighted capital in Irish banks compared to other countries.  I think we have the highest capital for SME lending and I think the third highest for commercial real estate or something according to the graph that was in there.  I’m just wondering, I mean I understand there needs to be consistency in how these rules are applied throughout Europe, but does Ireland not get a very raw deal in trying to get consistency?  You have to look at experience over a time period and that means that we’re catching a very bad period in Irish banking in our homes. But we seem to be still paying a very high cost. Obviously rules have to be consistent within the EU but is it a one-size fits all and Ireland comes out very badly?  And again, I was struck, another statistic in there…is it almost one in two mortgages now have been written since 2015 under the new macroprudential rules?  So, they should be very good mortgages, so why do we still need all those collateral?

Gabriel Makhlouf: Part of the answer is they’re EU rules.  So, they do apply, you know, everywhere. And there maybe is a case for review.  But the bottom line is we had a very, very, very bad crisis.  And we are still suffering some of the consequences of that. I mean, in two particular respects that are worth mentioning…we had the IMF in town a few weeks ago and then they’ll be publishing the outcome of a financial system assessment next month. One of the things in the conversation I had with them, I don’t know if this will be in their report, they mentioned our non-performing loans and the fact we’ve got these long-term mortgage arrears that still see some of them in the system.  And the other issue which we have talked about as being an issue for Ireland is that collateral here is not as secure as collateral elsewhere. So, the practical experience, when you talk to policymakers in Europe and say these rules have to be changed.  You know, one of the things they do is they say to you well actually you know; you guys still haven’t fixed some of the problems that you had back when.  You haven’t fixed the insolvency issues as an example, which is strength of collateral and that adds to the cost of our mortgages. But when you start talking to others about you know, would you change this, they’d go back and say why are you not changing some of the things, in particular on your insolvency work, securitisation, the collateral, and the ability to access security.  So, has Ireland got a bad deal?  Ireland did have a very, very bad financial crisis. 

Niall Brady: We are still… we’re paying a very high cost, now we’re still paying a very high cost in that we’re losing two of our biggest banks. 

Gabriel Makhlouf: I’m not sure it’s entirely right by the way to say that the banks are moving because of risk weights.  I think the banks are leaving for different reasons, they’re making commercial judgements and they’re quite different operations as well.  As I said yesterday, I think it is too simplistic to say that any regulatory decision is leading to banks deciding not to operate here. Because what’s fundamentally what’s happening is the whole of the sector is in transformation, it is being changed. We are seeing new entrants arrive but they look different, and they’re smaller. 

Niall Brady: Yes.  And they cherry pick. 

Gabriel Makhlouf: And they cherry pick right, because that is to a certain extent, that’s what new entrants do.  But you know, they know what market they’re coming into, they know what the issues are, they know what the framework is. Then they’re saying well this is how you can come in.  It doesn’t mean that this is the only thing they’ll ever do. But the market clearly has attractions still and it’s small, on the grand scheme things but it’s still … the domestic market, it’s still a small market.  I think I will be cautious about saying this is why Ulster and KBC are leaving because of this particular thing.  I think it’s more complicated than that. 

Niall Brady: And just, on the numbers that were in the report yesterday, the risk weights, they referred specifically to SME and commercial real estate lending.  So, but the issues of enforcing collateral aren’t the same as they are in the mortgage market. 

Gabriel Makhlouf: No, no, that’s right.  But what I’m saying is when you start talking about changing rules, which requires consensus at the European level, these sorts of things all come into play in the discussion. 

Niall Brady: And has that battle been lost in Ireland now?  I mean is…?

Gabriel Makhlouf: Oh, in Europe nothing’s ever lost. 

Niall Brady: But in Ireland as regards reforming say repossessions or foreclosure. 

Gabriel Makhlouf: I wouldn’t use that.  One, I wouldn’t use the word “lost”. Secondly, changing the whole issue of collateral actually is for government and in particular the department to decide. I don’t know if they’ve decided to do nothing. I would be surprised if they decide to do this.  I know the IMF raised it in the discussions that we had and I know they wanted to talk to interested parties who’ll gain from this.  But I don’t know what the… I can’t remember if that’s their responsibility.  But to say the battle is lost implies that nothing can ever change. I don’t think that’s case either. 

Niall Brady: Another thing you had in the report yesterday was just the whole issue of cryptocurrencies which is obviously very topical and I know that you were in the finance committee not so long ago about that as well.  One of the TDs maintains that one in five of us have invested in cryptocurrencies which seems remarkable.  I’m not sure where it comes from. 

Gabriel Makhlouf: I don’t know where that comes from. And I wouldn’t use the word invest. Well, you can do if you feel that buying a lotto ticket is also investing. 

Niall Brady: You’re a complete sceptic on cryptocurrencies. 

Gabriel Makhlouf: Yeah. 

Niall Brady: Is that a stupid question to ask Central Bank is it, or?

Gabriel Makhlouf: I don’t honestly add the word ‘currency’ to crypto, mostly.  I just talk about crypto. I did a blog on it maybe more than a year ago where I talked about digital money and I talked about crypto.  And I think the spectrum of things going on here has something about technology which may have - and I underline the word may - have beneficial reasons.  But I was interested to see a number of technologists in the United States argue that that’s not proven either. In other words the people who know more than I do about the technology disputed that. But I’m prepared to be more open minded about it.  Where I think frankly it’s completely unproven is that crypto has a substantive, a value-added role to play, in economic life. There’s no evidence of that. And then you have at the other end, Bitcoin is a good example and so is a bunch of other stuff, where essentially these are fundamentally Ponzi schemes where they’re trying to create markets, they’re trying to sort of get people put their money in and if you’re successful in getting people to put money in, and you’re quick enough to take your money out, you’ll make some.  But it’s not based on real value-added. I mean I think that’s just pure speculation and it’s got no role to play.  And the stuff that’s sort of potentially in the middle, I’m also not sure what value really is being added to economic life. Now you’ve got a group of people who tell you it’s all about… what’s the word?  You know, getting government out of the way. I’m trying to think of a particular word. But I mean you know, essentially, there are the evangelists who created all this because it’s all about privacy, it’s almost anarchy. It’s about getting central banks and governments out of the way. And I just think this whole thing is a con.  I, as an individual, am somebody who is prepared and happy to be proved wrong, you know.  So, if someone comes up and tells me here’s a brilliant idea that’s really helping the community, the public, in the following ways, you know, it’s a crypto thing. And no one’s done that. And all I have seen are people who essentially encouraging – this is the word used – investment in a thing that’s essentially just a big gamble and lottery. And when you get to a stage, as we had a couple of weeks ago, with that outfit Terra, who you know, were a stablecoin or asserted that they were a stablecoin. And what they were stabled to was an algorithm as opposed to … stablecoins in theory are meant to be backed by fiat money. The moment you get into this you know, well somehow we’ve got this magical thing, this is all magical thinking. So, it’s a very long response to you, but essentially, I don’t see any value really for society at all. 

Niall Brady: I know that you guys, you’re setting up a register, a virtual… what did you call it?

Gabriel Makhlouf: Asset providers.

Niall Brady: If I had an application in with you I wouldn’t be… I wouldn’t get my hopes up after hearing what you’ve just said. 

Gabriel Makhlouf: Well, the thing about the VASPs, some of them would be providing services that… some of them would be legal firms, accountancy firms who want to provide things in a virtual world. And they could be you know, people who’ve got serious propositions and they’ve given them serious consideration. And this is going to be my view, that’s what I’ve seen.  And if someone turns up and says we’re going to sell Bitcoin to whatever, we’ll probably look very sceptically at that. But, you know, a lot of people have been fooled into putting a lot of money into the lottery and some have taken, they’ve got money out.  But there are quite a few who’ve had their fingers burned in the last fortnight and I haven’t said anything at all publicly about the last fortnight because hopefully people will just see the evidence and what happened to Terra and Celsius, what happened to all these other things.  Just hopefully they’ll just ask those questions of what’s going on here. 

Niall Brady: Do you think is this another bout of volatility or is it the end?

Gabriel Makhlouf: I mean that’s a binary thing, I don’t think it’s the end because I think there’s a lot of money and people interested in it, so I can’t see it disappearing.  I suspect a lot of people will become slightly more cautious and more sceptical.  But at the moment, it’s still new, sexy technology. 

Niall Brady: It’s the buying opportunity, you know. 

Gabriel Makhlouf: Yeah. Celsius - I mean, they were offering 18% returns. I mean, honestly, in the world that we live in right now, if anyone offers you 18% returns, it is too good to be true.  But, if you’re a Joe you know, if you’re a punter, you think well the people down the road were offering me one point something.  And that is the history of finance since the world was created. 

Niall Brady: Indeed. And sorry, just very lastly obviously, you were clear yesterday that you know…America might think it’s heading for recession but we’re looking… you’re not expecting recession here. 

Gabriel Makhlouf: The evidence that we’ve seen at the moment doesn’t point to that. I mean certainly as I said yesterday, compared to where we were in January, we’re in a less good place because the war essentially got in the way of what we saw was robust growth.  So, things have slowed down. But a recession means we’ve got to have two consecutive quarters of negative growth. And at the moment, the evidence is more than ever. Now things may change dramatically in the world, so there’s always a risk. We don’t know whether the war is going to get worse and all the rest of it. What’s happening in the US, and the reason why some people are saying there’s going to be a recession, is that the Fed, in order to get inflation under control, is going to be forced to push up rates so much that that is going to stop things and lead to a recession in the US. I mean that’s not the strategy in which the ECB is following. So, I think the US and us are in a bit of a different situation. I mean I can only answer the question from what I see today, and from what I see today is an economy where the economic activity isn’t pointing at a recession.  And the labour market in particular, it’s not telling us that there’s a recession on. 

Niall Brady: And just very, very lastly on the report again yesterday had an interesting figure just on the spill over of mortgage exemptions to where you changed the rules last year and the spill over there has been of unused exemptions from last year to this year.  I was surprised by how big the number was.  I added up and I got about €800 million in a market that was worth €10 billion last year and if they’re to be used, they’re to be used in the first half.  Have you any feel for how… I presume…

Gabriel Makhlouf: I personally don’t. Now whether some of the team do, I don’t know. I mean you know, we introduced those changes because the industry was saying they wanted more flexibility. But we can ask the team that question. 

Niall Brady: Okay great.