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The main challenge, he said, is to implement regulatory reform that redirects the sector to support an economic recovery that has been very slow, while removing "perverse incentives" for banks to expand too much. He also called for solutions to counter the fragmentation of the financial markets that has affected struggling countries like Portugal, where Liikanen was speaking at a conference on Thursday.
Analysts fear the poor health of the eurozone's financial sector will dent the recent signs of recovery, and Liikanen said Europe should be wary of this. "It is essential that banks with unsustainable strategies are allowed to fail", he told the business conference in Porto.
Both Liikanen and fellow ECB board member Carlos Costa urged European banks to ensure they had adequate capital buffers to face next year's stress tests under a new eurozone-wide banking supervision mechanism. "We need to ask banks to have capital to absorb losses if needed", Costa said in a speech.
Liikanen, who heads Finland's central bank, said the crisis in Europe showed the importance of understanding when its banking sector is growing "excessively". He noted that leading European banks are very large compared to their international peers, particularly in relation to the size of their countries. "No one knows what is the right size of the sector, but we can remove perverse incentives for too much growth", he said.
For Costa, though, the problem was not "a matter of actual size" of any problem bank but of how complex some banks are. "We need to have simple Europe-wide banks but this does not mean we need to limit them in size", he said, adding that Europe should be more concerned about banks "too complex to govern" rather than those "too big to fail".
The ECB promised last week to put top eurozone banks through rigorous tests next year, staking its credibility on a review that aims to build confidence in the sector. "We are in a critical phase before the supervision mechanism starts. It is essential that we ask banks in Europe to improve capital", Liikanen said.