In my view there are two main areas today where this applies: first, ensuring that banks retain the incentives to lend in markets where to all intents and purposes they are irreplaceable, namely for SMEs; and second, ensuring that they have capacity to do so. Ensuring that banks’ retain incentives to lend Ensuring that banks retain the incentives to provide an elastic supply of credit to SMEs involves a variety of issues, but the priority in the current environment is addressing the factors that could drive unwanted adjustment in the sector: in particular, the cyclical, legacy and regulatory factors I described above. Cyclical factors matter for banks’ incentives because the longer weak demand conditions persist, the greater the risk that banks will shrink their balance sheets more than is necessary. Thus, a stronger recovery with stronger credit demand is a key part of repairing the bank lending channel. Achieving this means economic policies must do their utmost to bring the economy back to potential as quickly as possible, by strengthening both supply capacity and aggregate demand in the economy. As this is now high on the EU policy agenda, I will not dwell on it today. In terms of legacy factors, the main issue today is dealing with non-performing loans (NPLs).
13  Ryan, R., O’Toole, C. and McCann, F. (2014), “Does bank market power affect SME financing constraints?”, Journal of Banking and Finance. 6  BIS central bankers’ speeches  other words, it creates the conditions for diversity and competition within the sector so that an optimal market structure can evolve. Conclusion Let me conclude. Repairing bank lending channel after a major financial crisis is inevitably a long and difficult process. Monetary policy has an important role to play, but the agenda is also broader: it involves supply and demand factors, and multiple aspects of national and European policy. The steps we have taken so far to strengthen the banking sector are necessary conditions for a stronger recovery in credit, and I am confident that we will see increasingly positive effects. But as banks transition to a new business environment, ensuring that they continue to have microeconomic incentives that coincide with our desired macroeconomic objectives is essential, as is developing a banking landscape that is sufficiently efficient and diversified to sustain credit supply. BIS central bankers’ speeches  7