FRANKFURT (MNI) – The European Central Bank must ensure that
extraordinary liquidity support does not delay much needed adjustments
in the financial sector, ECB Executive Board member Lorenzo Bini Smaghi
said Tuesday.

“Liquidity support can help to reduce adjustment costs by smoothing
the transition. But those costs should not be used as a pretext for
delay,” Bini Smaghi said in a speech text prepared for delivery at the
Goldman Sachs Global Macro Conference in Hong Kong.

The central bank must thus “ensure that such liquidity support to
the banking sector does not delay or hinder the fundamental reforms
required to address the underlying weaknesses the financial crisis has
revealed,” he said.

“In the end, the crisis-hit countries have no alternative: they
have to make fundamental reforms to their banking systems, involving
substantial restructuring and, in some cases, very significant
downsizing,” Bini Smaghi asserted.

On Monday, fellow board member Juergen Stark already warned that
the ECB’s generous liquidity support “entails significant risks” and
called on persistent bidders to “take all appropriate measures to
reinforce their balance sheets as well as their capital base” to regain
access to the interbank market.

Bini Smaghi once again rejected the notion that a sovereign default
in the Eurozone is unavoidable, pointing to adverse implications for the
region and its banking system such a default might have.

“Given the much greater depth and intensity of financial and
economic integration in Europe, the strength of contagion across
financial institutions and markets is potentially more significant
within the euro area today than was the case in Asia in the 1990s,” he
said.

In fact, euro area countries would not be able to implement a
sovereign default without suffering “a major breakdown of their
financial, economic and social structure,” Bini Smaghi argued.

A sense of “common destiny” among Eurozone member states has led to
exceptional financial commitments that are closely binding member states
to the success of Greece’s and Ireland’s bailout programme, he pointed
out.

“As a result, creditors, in particular official creditors, are
therefore more closely bound into the success of the programme and have
a strong incentive to ensure that the programme’s conditions are
fulfilled, thereby underpinning its success,” he said.

–Frankfurt bureau, +49-173-6529-331; jtreeck@marketnews.com

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