The Fiscal Compact also accelerates the application of the excessive deficit procedure by introducing sanctions when the debt and deficit to GDP ratios are excessive. Fiscal surveillance has been extended to a broader excessive imbalances procedure, which goes beyond fiscal imbalances and seeks to identify and correct a range of macro imbalances and shortcomings in competitiveness. In fact, various euro area member states ran into problems despite of their adherence to the SGP criteria, to the extent that they nonetheless manifested other types of imbalances, such as excessive private indebtedness. Preventive recommendations are provided to member countries at an early stage in the formation of imbalances. The severity of the financial crisis has also exposed the inadequacy of the current financialsector regulation and supervision. As already indicated, macro-prudential risks were overlooked and the link between sovereigns and banks was underestimated. In reaction to this, European institutions and member states have engaged in a major overhaul of bank regulation and supervision with the objective of creating safer, sounder and more transparent financial institutions. One of the major initiatives to strengthen the governance framework was the establishment of the European Systemic Risk Board (ESRB). In its first year of operation, the ESRB tackled key issues relating to the interaction between three factors: the creditworthiness of European sovereigns, the increasing difficulty of banks in raising funds, and weakening economic growth.

This is designed to repair the link between policy rate cuts and ample liquidity provision, on the one hand, and lower borrowing costs, on the other. It is also meant to counter the socalled redenomination or convertibility premium that compensates investors for the perceived risk of a breakup of the monetary union. OMT are actually equivalent to traditional open market operations that central banks have long resorted to in order to provide stability and a better functioning of the monetary transmission process that can get impaired in certain circumstances. The unfolding of the crisis has revealed various intertwined dimensions of the existing fragilities and a broad range of imbalances. In various ways, the problems that are evident in the euro area are of a structural nature, resulting in a number of governance reforms that are currently underway. Inappropriate banking practices, weak regulatory frameworks, fiscal slippage and deterioration in competitiveness are now recognised as the main sources of the crisis. A fundamental aspect of the banking crisis is the failure of regulation, which allowed financial institutions to engage in excessive risk that was not matched by adequate capital protection. Systemic risk was exacerbated via strong linkages between financial institutions. Economic fragilities were worsened by the burden imposed on government budgets by bank bail-outs, the lack of market funding available to sovereigns, and the negative impact of sovereign debt downgrades on bank balance sheets. Lack of trust spread across the euro area, with this contagion creating a mutually reinforcing loop between weak sovereigns and bank credit conditions.