currently fare in achieving the two objectives of the single market, allocation and diversification? allocation looking at credit developments in the euro area, in my view we still have a way to go to separate allocation from location. there are two ways in which i see that location still matters for credit : via the location of borrowers and of lenders. first, in the euro area today it is the location of borrowers, rather than their creditworthiness per se, that matters most for access to finance, in particular for smes. credit supply in the euro area as a whole is most likely sufficient to meet aggregate credit demand. the problem is that cross - border frictions and high levels of uncertainty prevent credit markets from clearing. in a true single market, a creditworthy sme that could not borrow from a domestic bank would borrow directly from a bank located in another member state instead. thus, the more efficient supplier would take market share at the expense of the less efficient one. but the mismatch between credit conditions in the euro area core and periphery shows this is not the case. part of the explanation is that banks ’ credit assessments are influenced by the health of local sovereigns – rather than just the characteristics of the firm. but this is not the whole explanation. even if sovereign risk were zero across the euro area, most banks are not structurally set up to provide cross - border lending. direct cross - border loans to non - financial corporations account for just 7. 5 % of total loans to firms. and local affiliates of foreign banks represent on average only around 20 % of national markets, and much less in larger countries. the upshot of this lack of contestability in national markets is that domestic banks gain significant market power. and recent research suggests that this is negative for allocation : where banks face limited competition in their domestic markets, and firms are more see for example krugman, p. ( 1991 ), “ increasing returns and economic geography ”, journal of political economy, 99 ( 3 ). bis central bankers ’ speeches dependent on them, financing constraints for smes have been higher. 3 this suggests that a more integrated retail banking market and more balanced financing mix would better support growth in the euro area. the second way in which location can affect allocation – the location of lenders – matters to the extent that non - economic factors influence banks ’ business decisions. one dimension to this issue is the connection between local banks and local interests. there is intrinsic value for retail banks

challenges ahead a side effect of the three - year ltros is that the banking system in the euro area is now in a situation of abundant excess liquidity. “ excess liquidity ” ( defined as the difference between outstanding open market operations and the liquidity needs from autonomous factors and reserve requirements ) currently stands at around €800 billion and is expected to remain at roughly this level at least until the end of january 2013, when banks will be able to exercise the option of early repayment on the first three - year ltro. the leeway for a reduction in outstanding refinancing operations before that date currently amounts to around €100 billion, and the scale on which banks will exercise early repayment options is difficult to anticipate at the current juncture. as a consequence, the balance sheet of the eurosystem has grown to €3 trillion. this large increase is a symptom of malfunctioning money markets and reflects the fact that the eurosystem has replaced much interbank activity. when the situation stabilises and money markets go back to functioning normally, the balance sheet of the eurosystem will also go back to its normal size. to this respect, the eurosystem is often compared with other major central banks. such comparisons however disregard the initial size of balance sheets, as the eurosystem holds a large volume of assets that have nothing to do with monetary policy. in early march, the ratio of monetary policy instruments to regional gdp was 15 % for the eurosystem, 19 % for the federal reserve system and 21 % for the bank of england. this large amount of excess liquidity has drawn criticism of two different kinds. some observers have argued that since banks are re - depositing with the ecb large amounts of liquidity, the injected liquidity is not circulating within the system and therefore the ecb ’ s actions will be ineffective in preventing deflationary pressures. others, however, have warned that since these large amounts of excess reserves may remain in the system for a relatively long time, if they are not appropriately absorbed they will hamper the ecb ’ s ability to keep inflationary pressures in check. these fears are of course contradictory. in order to dispel them, let ’ s look more closely at the channels of transmission through which the excess liquidity circulates in the system. the first criticism – that large - scale use of the deposit facility demonstrates the ineffectiveness of ecb ’ s measures –