Second, declines in the market value of government bonds led to liquidity strains, insofar as these bonds are widely used as collateral in interbank markets. And third, in some instances, governments had to step in to recapitalise vulnerable domestic banks, thereby increasing their own debt in turn. This “tale of two debt overhangs”, as some have called this twin crisis of banks and sovereigns, had uneven effects across euro area countries.4 Some countries were markedly more affected than others, which contributed to increased financial fragmentation in the euro area. This also laid bare further fragilities that had been accumulated in the past, including the fact that some euro area countries had neglected structural reforms and as a result faced competitiveness losses and the built-up of external deficits. While these fragilities had not gone completely unnoticed, and had been pointed out early on by the ECB, they had not received the attention they deserved until the crisis struck. This bears similarities with the Asian financial crisis, which is well remembered in this part of the world. Some experts saw it coming and warned at an early stage against the causes that led to it, such as short-term  1  See e.g. Berkmen, P., G. Gelos, R. Rennhack and J. Walsh (2009), “The global financial crisis: Explaining cross-country differences in the output impact”, IMF Working Paper, No. 280; Berglöf, E., Y. Korniyenko, A. Plekhanov and J. Zettelmeyer (2009), “Understanding the crisis in emerging Europe”, EBRD Working Paper, No. 108; Lane, P.R. and G.M.

At the same time, the standard monetary policy action was judged as insufficient because, during the crisis and especially from 2010 the interest rate channel of the monetary policy transmission mechanism was impaired, initially because the interbank market was dysfunctional, then because the banking sector in some countries became itself dysfunctional and was unwilling or unable to perform its normal intermediation role. In response to this challenge, the ECB engaged in a sequence of non-standard measures to restore a proper transmission of the monetary policy impulses, including lending operations through a fixed rate tender procedure with full allotment, the provision of liquidity with longer maturity and an expansion of the set of assets that could serve as collateral for receiving central bank liquidity. As financial integration in the euro area was being severely eroded and banks largely retrenched within their national borders, the Eurosystem remained ready to provide liquidity at consistent and uniform conditions over the entire euro area, as it should be in any monetary union. As a further step to address the banks’ funding problems and financial fragmentation within the euro area, the Eurosystem started intervening directly in securities markets in order to correct severe mal-functioning of certain segments. The first action of this type was the Securities Markets Programme (SMP) launched in May 2010, followed by a purchase programme for bank-issued covered bonds started in October 2011, and finally the Outright Monetary Transactions (OMT) programme announced in September 2012 but so far not activated.