By the end of 2008, the problems of banking sectors – in the US, Europe and elsewhere – and the need for massive deleveraging had become apparent. At the same time, the interbank market was severely disrupted, and so was the transmission of monetary policy impulses to the real economy. The measures adopted by the Eurosystem were geared at restoring the functioning of its transmission mechanism, and at supporting the continued availability of credit to households and non-financial firms. As a result of increasing tensions in the sovereign debt markets since 2010, the situation of the euro area financial sector worsened. Doubts about the sustainability of sovereign debt levels in some countries of the euro area led to significantly increased levels of sovereign bond spreads. This, in turn, also led to higher interest rates in the private debt markets of the affected countries. It became apparent that the health of the national banking sector was often closely intertwined with the health of the local sovereign: funding problems in the banking sector and weak fiscal positions mutually reinforced each other. Significant heterogeneity emerges when looking at changes in the bank balance sheet items in different countries of the euro area, primarily concerning changes in deposits and in credit growth.
2  BIS central bankers’ speeches  to the non-financial sector.3 Therefore, the potential for a very large amplification of shocks to the real economy is particularly strong in the euro area. In such situations, the transmission mechanism of standard monetary policy impulses may become impaired and the central bank has to resort to non-standard measures. Let me elaborate on that. In normal times, central banks provide liquidity to the banking sector through open market operations. Typically, banks obtain central bank liquidity against the provision of central bank eligible collateral in a repo transaction. By setting the interest rate of its open market operations, the central bank can directly steer the risk-free rate in the short end of the money market. This then feeds through to other, longer-term interest rates and ultimately to credit conditions applied to the real economy. During financial and especially banking crises, banks’ demand for central bank liquidity may sharply increase to compensate for the decline in other forms of banks’ liabilities, often resulting from withdrawals of bank deposits. By accommodating such an increase in the demand for liquidity, the central bank is the only agent able to prevent a process of disorderly money-supply contraction. The stabilising role of the additional liquidity is especially strong if it is supplied for longer maturities. In this way, access to central bank liquidity allows banks to obtain funding at the policy rate – as long as they have the required collateral and a sound business model.