christian noyer : banking in the euro area speech by mr christian noyer, vice - president of the european central bank, at the 30th anniversary of the association of foreign banks'representatives, frankfurt, 8 november 2001. * * * i am very grateful for the invitation to speak to you on the occasion of the 30th anniversary of the association of " foreign banks'representatives in germany ". your association has 117 members from a large number of countries. several of the member institutions are counted among the 30 major european banks, or among banks from elsewhere with important operations in europe. for many banks represented by your association, the topic of my speech " banking in the euro area " is part of day - to - day business. it is also day - to - day business for the european central bank ( ecb ) and the eurosystem as a whole, as we conduct our monetary policy operations and run the target large - value payment system. the further integration of the european banking system and financial markets is in the interests of both banks and the central bank. for banks, it means the liquidity benefits of deeper and wider markets and lower costs when operating in several countries. from the central bank perspective, it enhances the efficient and consistent implementation of the single monetary policy. we already enjoy the benefits of a common euro area banking system in important respects. an integrated money market exists for liquidity transfers in euro ; banks are inter - connected in a common payment system infrastructure ; and wholesale securities market activities and corporate finance services do not recognise geographical borders. however, at the retail level, international banks must still treat each country as an individual market. this is because of localised demand and country - specific banking products, and differences in conduct - of - business and consumer protection rules. the remaining differences in regulatory and supervisory practices can also play a role. i believe that few institutions understand this as well as you do, as you still have to cope with the task of navigating business through various national environments. i should like to explore this double feature of euro area banking today. on one hand, there is the challenge for central banks and supervisory authorities to respond to the emergence of a common wholesale banking system in order to maintain financial stability. on the other hand, greater integration, also in the retail field, remains an important policy objective. i should like to address the two aspects in turn, starting with wholesale banking and then moving on to the retail side. a common wholesale banking system i share the

- term deposits with embedded derivatives tailored to the needs of investors. taking into account the effects of financial innovation is a clear challenge for monetary analysis. meeting this challenge requires regularly updated tools and in - depth research based, in particular, on sectoral analysis. 2. by affecting the transmission mechanism, financial innovation is also a challenge for the conduct of monetary policy a good knowledge of the mechanisms through which monetary policy affects the economy is of crucial importance for central banks. financial innovation affects these mechanisms both by altering the channels through which monetary policy operates and by changing the overall impact of monetary policy decisions. but the magnitude of the changes and the precise effect due to financial innovation at a time when other factors such as globalisation are at work are not well known. at the present juncture research shows that financial innovation tends to strengthen the interest and exchange rate channels whereas it appears to weaken the credit channel. - financial innovation certainly contributes to stronger wealth effects and thus probably also to strengthen interest rate channel 7. this can be explained as follows : • financial innovation fosters faster dissemination of information and its more rapid incorporation into financial market prices. this is of course particularly true for monetary policy decisions and can therefore increase the effectiveness of monetary policy, particularly via the interest rate channel 8. • financial innovation contributes to an increased holding of financial assets by lowering transaction costs and facilitating arbitrage, hedging, funding and investment strategies. • financial innovation often relies on stronger leverage, increasing the effect of interest rate change by the central bank. one example of this enhanced impact is provided by the behaviour of hedge funds who customarily borrow short - term funds to finance their ( longer - term ) investments 9. - turning to the exchange rate channel, financial innovation results in greater integration of domestic and international financial markets, which should also strengthen the exchange rate channel as exchange rates become more sensitive to interest rate differentials between currency areas. this has been illustrated by the recent debate about cross - border carry trades 10. - at the same time, financial innovation has probably weakened the credit channel 11. several phenomena may be at play : • financial innovation gives firms broader access to securities markets, which may reduce information asymmetries at the source of the credit channel. bis, 1994 noyer, 2001 weber, 2007 weber, 2007 bis, 1994 ; thornton, 1994 • more specifically, securitisation by banks has reduced their liquidity constraints and thus further weakened the credit channel. a recently published research paper by the new york