This can hinder central banks in pursuing price stability. Before the crisis, the interaction between monetary policy and the banking system was well understood. During the crisis, this interaction was starkly highlighted. The banking system failed as a channel of monetary policy impulses, and instead contributed to propagating shocks. Banks became mired in painful but necessary balance sheet repair efforts.
As a result, they have been restrained in supporting economic recovery. Banks’ crucial role in the financial intermediation of the euro area explains why many monetary policy interventions during the crisis were aimed at repairing the bank lending channel. The ECB was confronted with a systemic liquidity squeeze, and had to accommodate the funding needs of the banking sector.