2 Banks nonetheless face expectations from shareholders to raise profitability and returns on equity above their current levels – as reflected in a rather high cost of equity – which many will have to react to by adapting their business models. This could involve a variety of measures, including repricing loans, reducing operating costs or streamlining business models – for instance, by shrinking credit provision in less profitable business lines, or exiting those business lines altogether. As policymakers we are in principle indifferent to how individual banks respond. But some of these strategies, when aggregated, may have system-wide effects that, as monetary policy operates mainly through banks, become relevant for our policy objectives. 2  2  For example, Altunbas, Manganelli and Marques-Ibanez (2011) document that over-reliance on market funding was a major source of bank risk in the recent crisis. See Altunbas, Y., Manganelli, S. and MarquesIbanez, D. (2011), “Bank risk and business models during the Great Recession”, ECB Working Paper No. 1394. BIS central bankers’ speeches  For example, repricing may counteract our monetary policy objective to ensure there is sufficient financing for a robust economic expansion. If banks lower costs in the short-term through underinvestment rather than efficiency gains, this may undermine their viability over the longer-term. And perhaps most importantly, if banks exit certain business lines due to the pressures of the difficult environement, this may imply cutting back on types of lending that are macroeconomically important, such as lending to SMEs or long-term infrastructure financing.

Moreover, the effect of bank market power on financing constraints increases in financial systems that are more bank dependent. 13 This underscores the general need, as I mentioned earlier, to create a more balanced financing mix between banks and capital markets. But it also points again to the particular importance of securitisation. With well-functioning securitisation markets some of the benefits of cross-border banks – for instance risk-sharing – can be replicated by having small, local banks originate-to-distribute loans while larger, global banks securitise and market them. In  9  See for example Anna Kovner, James Vickery, and Lily Zhou, “Do Big Banks Have Lower Operating Costs?,” Federal Reserve Bank of New York Economic Policy Review, Volume 20, No. 2, forthcoming. 10  “Financial Integration in Europe”, March 2007. In line with this, Carletti, E., Hartmann, P., and Ongena, S. (2007), “The economic impact of merger control: What is special about banking?”, ECB Working Paper No 786, July, find empirical evidence that the opacity of national bank merger reviews entered elements of inefficiency in banking relative to non-financial corporate sectors. 11  For a discussion on why retail bank integration may be a particularly attractive risk-sharing mechanism, see e.g. Fecht, F., Grüner, H.P. and Hartmann, P. (2007), “Welfare effects of financial integration,” CEPR Discussion Paper No. 6311. 12  See for instance Reinhardt, D. and Riddiough, S. (2014), “The two phases of cross-border banking flows”, mimeo, Bank of England.