In this regard, the banking union with effective supervision and bank resolution can foster the necessary restructuring in the euro area banking sector, can further spur balance sheet repair and can restore the banking sector’s intermediation function. In particular, a European resolution mechanism with adequate powers and tools will be needed for effective resolution without involving taxpayers’ money. At the same time, this framework will ensure the revitalisation of the banking sector and revive financial integration. The early repayment by banks of the liquidity received from the first three-year LTROs has given initial mild indications for improvements in banks’ funding conditions and the overall health of the banking sector. But complacency is not warranted. Balance sheet repair in the euro area banking sector has to continue to fully restore wholesale and interbank funding markets, which will allow banks to return to their normal sources of funding, releasing them from the strong dependence on central bank intermediation, particularly in the case of banks receiving ELA. Conclusion Let me conclude. The sovereign debt crisis has thrown into reverse the steady financial market integration seen since the inception of the euro. This trend was largely driven by the link between banking and sovereign risks. 6  BIS central bankers’ speeches  The crisis has hampered financing conditions. By consequence, the monetary policy transmission channel has been clogged and ECB has been compelled to apply unconventional measures to repair the distorted flow of credit in the euro area.

On the one hand, high fiscal deficits and debts eroded confidence in the ability of some governments to support domestic banks, increasing their counterparty risk vis-à-vis banks located in countries with sounder fiscal positions. On the other hand, bank fragility had severe budgetary implications in some countries as public funds were mobilised to recapitalise ailing institutions. In addition to the impact of financial instability, fiscal fragility also affected financial integration directly, by creating an uneven playing field among institutions: banks in countries with fiscal problems were consistently confronted with higher funding costs, reflecting the higher headline risk of the sovereign. Moreover, government guarantees on bank bonds, an instrument that has been widely used during the crisis, had different values depending on the fiscal situation of the sovereign. Furthermore, in an environment of dried-up liquidity, the large refinancing needs of some governments led to concerns that the public sector would  2  BIS central bankers’ speeches  crowd out bank debt issuance. National banking systems with the highest exposures to domestic sovereign markets were hit particularly hard through this channel. Inadequate institutional safeguards At a more fundamental level, however, this instability and fragmentation of euro area financial markets was the unavoidable consequence of a structural inconsistency in the European monetary and financial architecture, namely the dichotomy between, on the one hand, a common currency and central bank and, on the other, a system of banking regulation, supervision and safety nets that is largely organised along national lines.