Let me finish by adding a word of caution. Regulatory devices per se do not suffice to attain a safe and sound banking system. A proper risk management culture deeply ingrained in banks’ practices is also a necessary condition to reach that goal. Consequently, banks and regulators should work hand in hand to improve financial stability. BIS Review 35/2002  7
Monetary policy in the Euro area Against this background, the role of monetary policy has become, and is likely to remain, more accommodative in the Euro area. The ECB has played a major role in supporting economic growth using its interest rate policy – now at near zero levels – and policies designed to influence credit provisioning and risk reduction. The ECB has also reaffirmed that, if necessary, further measures will be taken to counter the risk of a prolonged period of low or negative inflation and to bring inflation to its medium term target of under but close to 2%. The possibility of a deflationary situation materializing in the Euro area is of concern as its dynamics would raise real interest rates. It would penalize investors and increase the burden of holding business inventories. It would also discourage consumption, as buyers await lower prices by delaying spending. A de-anchoring of inflation expectations carries a risk of the Euro area becoming stuck in a stagnant environment for a prolonged period of time. Basically, a deflationary scenario would be inconsistent with what is needed to support an economic recovery in Europe. The effectiveness of monetary policy in the Euro area depends on a properly functioning banking sector, since the transmission of monetary stimulus operates at least partly through the bank lending channel. In the Euro area, the debt overhang in the private sector and the balance sheet position of the banks have been hampering the transmission and effectiveness of the ECB’s accommodative policy measures.