Document 2: Speech by Mario Draghi

Speech by Mario Draghi, December 15, 2011

To explain our recent monetary policy measures, let me recall the particular role of banks in the euro area economy. The flow of credit to firms and households in the euro area works largely through banks. During recent years, about three quarters of firms’ external financing have come from that source.

This means that any impairment in the bank lending channel will have stronger consequences in the euro area than in other economies where firms’ external financing comes largely from corporate bond markets.

Banks in the euro area have recently come under pressure both as regards their capital bases and their funding conditions.

The plan to strengthen their capital bases is an attempt to reinforce their standing in financial markets, but this is not an easy process. There are essentially three options for banks to pursue to raise their capital ratios as demanded by the European Banking Authority: they can raise their capital levels, sell assets or reduce their provision of credit to the real economy.

The first option is much better than the second, and the second option is much better than the third. But raising capital levels is expensive in a depressed market and faces resistance from shareholders. Selling assets is less preferable and curtailing credit to the real economy is even worse. Therefore, public authorities ought to cushion the impact on the real economy and banks should consider restraining dividends and ad hoc compensation to strengthen buffers.

Banks are also facing problems in raising longer-term funding in financial markets. The resulting shortening of their funding leads in turn to maturity mismatches on balance sheets of the kind that caused the financial crisis.

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