The Eurosystem has provided – and is still providing – support to those national banking systems which face liquidity needs. I would like to underline that the key precondition for such a support is that the country concerned sticks to the EU/IMF adjustment programme and are on track. In other words, the responsibility for ensuring the conditions for the Eurosystem to support the banking system of the countries under stress is with the authorities of the countries themselves. There should be no doubt about it. 5  For further details, see Trichet, J-C. (2009). “The ECB’s enhanced credit support”, address at the University of Munich, http://www.ecb.europa.eu/press/key/date/2009/html/sp090713.en.html. 4  BIS central bankers’ speeches  The support provided to the banking system has been substantial. It is reflected in financing conditions at the euro area level, which have become more favourable of late, amid an ongoing gradual normalisation. Recent euro area bank lending surveys show signs of improvement in credit conditions compared with the peaks recorded during the apex of the financial crisis. While in most euro area Member States we have seen broadly unchanged or slightly loosened credit standards over the past few quarters, in a few others the bank lending surveys point to constraints remaining in the supply of bank loans to firms and households.
These dynamics are captured in the simple specification  where  indexes time,  are iid normal shocks and  is the indicator  function taking value 1 when and value otherwise. As reputational concerns disappear, the term goes to zero, leaving simple autoregressive dynamics. But with reputational externalities, productivity shocks become amplified by the credit cycle: a high realisation of in period could push the macro state above the risky policy threshold, at which point the dynamics of begin also to shape the real economy. The distribution of is assumed to have a higher mean and variance than to simulate the effects of the credit boom. In particular, we constrain the distribution of relative to such that expected risk-adjusted fundamentals are constant over time. 10 So we have, in effect, a regime-switching model. When banks play safe strategies, fundamentals are relatively stable. When banks risk up, they create a temporary improvement in expected fundamentals at the cost of greater volatility. This dynamic specification has some interesting properties. First, even small shocks can have disproportionately large effects on fundamentals depending on the initial conditions. In particular, if fundamentals happen to be close to the switching threshold, a further positive shock will lead all firms to coordinate on the high risk-taking strategy. That drives up both the expected value of fundamentals and its volatility. This generates a form of path dependence. Second, credit cycles are endogenous in this framework. As firms coordinate on high risk strategies, this drives up the expected value of fundamentals.