Lorenzo Bini Smaghi, a member of the European Central Bank Executive Board, today suggested that the ethical and farsighted use of European bank profits is lending.

European banks have enjoyed higher trading income, largely due to the low interest rates, according to Bini Smaghi. However, he warns that there are substantial risks involved in these trading activities, noting that short term interest rates will eventually be raised. In addition, he warned about the dangers of banks trying to unwind their currency carry trades at the same time in the event of an adverse move.

The strategic decision is for banks to use the trading profits to strengthen their capital position in order to make loans as demand will rise in the future, he said. The profits should not be used to pay employees and shareholders.

Bini Smaghi also emphasized the morality this proposal because banks have benefited from the fiscal and monetary assistance of the government. For banks that did not receive direct government funds, they still benefited from the massive liquidity, he added.

He noted that bank loans to businesses have fallen since the financial crisis and that bigger firms in Europe have turned to public debt for financing. The small and medium-sized enterprises (SMEs), who depend strongly on bank financing, had more trouble in obtaining financing.

Bini Smaghi emphasized the vital role banks will have to play in the recovery because monetary and fiscal policy, although successful in averting a more severe recession, cannot alone achieve economic recovery. SMEs, in particular, need banks to finance their projects and working capital, he said.

Along with bank lending, Bini Smaghi also proposed structure reforms that increase competition among firms to help the economy get on track.