The logic is easy to see: a reduction in short-term risk-free rates typically leads yield-oriented investors to rebalance their portfolios towards riskier assets, either along the yield curve or across asset classes. This channel is even more powerful when rates are negative: it sets strong incentives for investors to move away from short-term assets so as to ensure non-negative income flows (see Slide 4). Market stress considerably weakens this portfolio rebalancing channel. And although markets have calmed gradually, both in the euro area and in the United States, stress indicators remain at an elevated level compared to the pre-crisis period (see Slide 5). In such conditions, two sets of policy measures tend to be most effective: those acting directly on banks’ funding conditions, and those, such as asset purchases, that alleviate investors’ balance-sheet constraints. The bank-based measures materially reduce the potentially adverse impact of tightening marketbased funding conditions on lending to firms and households. In the euro area, this risk is real: 3/7  BIS central bankers' speeches  banks still face considerably higher refinancing costs in markets than before the crisis, both for secured and unsecured borrowing. Our targeted longer-term refinancing operations (TLTRO III) address this wedge in our transmission process at its root. Provided banks maintain their lending to the real economy over the next year, they can benefit from rates as low as –1%. Given these highly favourable conditions, surveys point to significant take-up for TLTRO III, in the order of € 1.4 trillion.

Operating cost of domestic banking institutions has declined from 41.2% in 2001 to 40.3% of total income in 2003. There have also been improvements in turnaround time in processing loans and in response time in resolving customer problems. •  There has also been a higher level of innovation and introduction of new products and services to meet the customer needs that are becoming increasingly complex and sophisticated. These services include wealth management, structured investment products, bancassurance and Islamic financial products. •  New delivery channels through innovative technology-based mechanisms such as internet and mobile banking have enhanced the delivery of products and services as well as widened access to banking services. •  Despite a more competitive environment, domestic banking institutions have been able to sustain their market share at 80%. The domestic banks commanded a 83% share of the outstanding loans to the small and medium enterprises, while their market share in the credit card business has increased from 46% in 2000 to 54% of total credit cards issued in 2003. •  With the increased investment in risk management systems, the risk management capability in the banking sector has been further strengthened on all fronts through increased availability of risk management tools. This has been reinforced by enhanced prudential policies. Banking institutions are now better positioned to withstand challenges arising from unfavourable developments. •  The resumption of credit growth has now gathered momentum to meet the growing financial demands of the economy, while keeping risks at acceptable levels.