I will then describe how the injection of long-term liquidity has helped to avoid a sudden curtailment of financing to the private sector by alleviating funding pressures on the banking system. I will go on to consider some of the challenges the Eurosystem is likely to face in the near future. Credit developments to households, non-financial corporations and small and medium-sized enterprises (SMEs) During the last quarter of 2011, monetary and credit developments to the private sector were exceptionally weak. The annual growth rate of monetary aggregates declined significantly in December, and it was mirrored by similar developments in lending to the private sector, especially loans to households and non-financial corporations. Clearly, as the sovereign crisis intensified it impeded banks’ support for the real economy. The annual growth rate of banks’ credit to the private sector decreased in the last quarter of 2011, reflecting monthly negative outflows and reaching troughs comparable with those prevailing in 2008–2009. In particular, the rate of growth of loans to households declined, reflecting both demand-side factors (such as a deterioration in the prospects for the economy, and notably the housing market) and supply-side factors (such as increasing funding difficulties for banks) (Slide 1). Incidentally, these developments masked significant cross-country heterogeneity, as some countries saw an increase in flows supported by government measures aimed at the housing market. The annual growth rate of loans to non-financial corporations declined as well, reflecting particularly weak quarterly flows (Slide 2).
In addition, the ECB has the right to issue debt certificates, and, if necessary, we could also decide to increase banks’ reserve requirements again. Reverting to the 2% reserve requirement ratio that prevailed until December 2011 would reduce excess reserves by approximately 100 billion euros. So, we are well equipped to cope with any issues arising from excess liquidity. There is a third concern which I would like to touch upon, and which I consider to be a serious one: the risk of moral hazard behaviour triggered by the non-standard measures. The large liquidity injections have avoided so far a disorderly deleveraging of the banking sector in the euro area as well as a dangerous credit crunch, but they have not removed the underlying causes of the turmoil. If governments and banks would stop or slow down their consolidation efforts and structural reforms, this would undermine the positive effects of the liquidity operations. Following the signs of improvement in the financial environment, it is therefore essential for banks to strengthen their resilience further, even by retaining earnings. The soundness of banks’ balance sheets will be a key factor in facilitating an appropriate provision of credit to the economy. Very low interest rates and ample liquidity conditions may be disincentives for banks to avoid recognising the loss by rolling over loans extended to borrowers who are unable to pay back the principal (the so-called “evergreening” of loans).