The expected benefits should in the long run outweigh the costs associated with giving up national monetary and exchange-rate policies as adjustment tools. Today, however, I do not want to focus too much on this traditional optimumcurrency-area debate. Instead, I would like to highlight another aspect of euro adoption, the implications of euro adoption for financial stability. By reducing exchange rate risk and currency turbulence, monetary integration provides easier and safer access to foreign capital. Therefore, it can be expected that it would lead to more efficient allocation of resources, faster real convergence, better inter-temporal consumption smoothing and more efficient diversification of risk. In this sense, euro area entry augments the benefits of international financial liberalisation. At the same time, it reduces many of the financial stability costs associated with the liberalisation process, such as currency crises, currency mismatches in the economy, and high exchange rate volatility. I would like to emphasise, though, that euro adoption should not be considered a panacea in terms of financial stability. The euro will not solve all the challenges faced by the acceding economies in a world of fully liberalised financial markets. The euro will address some of these challenges, but it may generate new ones, equally serious in nature. The benefits of freer access to foreign financing may be plagued by vulnerabilities and resulting turbulence. The only change may be in the type of risks, with a shift from exchange rate risk to other risks in the domestic financial system.

At present, this ratio exceeds 100 percent in all these three cases. The trend has been also growing fast in Greece, albeit from a lower base. In Portugal, for instance, domestic banks took the opportunity to issue eurodenominated bonds in euro area markets to increase rapidly the volume of domestic loans both to the corporate sector and to households. Capital inflows through banks financed a mounting current account deficit. It also fuelled fast growth of domestic demand and GDP in 1998-2000. This experience could in principle be viewed as a manifestation of the expected potential benefits of monetary integration. In fact, it has been argued that euro area membership has enabled the participating countries to overcome the famous Feldstein-Horioka puzzle, i.e. the traditional strong link between domestic savings and investment. In other words, the current account constraint may become non-binding after euro adoption, which should lead to a more efficient allocation of capital in the long run. However, it might be also questioned whether such a fast credit expansion will lead to a build-up of vulnerabilities in the balance sheets of financial institutions, firms or households. In the case of Portugal, for example, the debt burden of the household sector has exceeded 100 percent of yearly disposable income, even though a decade ago this ratio was comparable to the current situation of some acceding countries. As a result, one can think of adverse scenarios in which the repayment capacities of the banks’ clients would deteriorate substantially, with adverse consequences for financial stability.