For instance, the supervisory authority may put pressure on banks to increase the level of capital – for example, through upward adjustment of capital requirements under the Basel III framework. In addition, authorities may resort to bail-in measures whereby a bank’s existing debt holders would be forced to convert parts of their debt into bank equity or to accept a (partial) write-down of their claims. Of course, authorities face several constraints, due to the lack of specific powers to force resolutions, for example, or incentive problems leading to delayed action. For instance, bail-in measures may take some time to administer because of the complexity of large banking groups and the various legal issues involved. In this context, Europe faces specific challenges given the lack of harmonisation of national systems, which strongly complicates the resolution of cross-border banks. Significant steps are being taken to overcome these shortcomings. I will return to this topic after discussing the implications of deleveraging for monetary policy. Monetary policy and the deleveraging process Whereas the deleveraging of the banking sector is a necessary process to correct the imbalances built up prior to the crisis and to bring the economy back to strong and sustainable growth path, “disorderly” deleveraging can represent a serious threat to price stability. I have already described some of the mechanisms through which deleveraging can spiral off. I would like to now focus on the implications of deleveraging for the transmission mechanism of monetary policy.

Otherwise, such differences might become a source of financial fragmentation in their own right. Neither of these criteria is easy to fulfil. As the experience with Lehman Brothers has demonstrated, failures of large, integrated financial institutions can have devastating consequences for economic stability. Risks of contagion from one institution to entire financial sectors greatly complicate any effort to establish a more symmetric risk and rewardstructure for banks. Harmonising financial sector policies across countries in turn requires substantial operational and legislative efforts, given that national institutions have evolved separately and are now heterogeneous in many regards. All these difficulties can be addressed and, in fact, they are being addressed by European policy-makers. In particular, the recent initiatives at European level comprise several crucial steps to achieving a more incentive-compatible as well as a more integrated and coherent framework among countries. Let me elaborate on several concrete elements. The first step is the establishment of a Single Supervisory Mechanism (SSM). The SSM aims to ensure that all supervisory decisions about euro area banks are taken in a consistent and stringent manner, independently of the country in which it is located. Once fully effective, this will reassure markets that all banks face the same scrutiny and thus will counteract financial market fragmentation in the euro area. Moreover, by delegating supervisory decisions from the country to the euro area level it facilitates the internalisation of cross-country spill-overs, thus allowing for more efficient outcomes.