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ECB's Mersch: Banks need to be strong enough to meet credit demand

SHANGHAI (Reuters) - Euro zone banks need to be strong enough to support a pick up in credit demand to keep the euro zone recovery going, European Central Bank Executive Board member Yves Mersch said on Saturday.

Tougher regulatory standards and a stronger sense of risk-aversion in the wake of the financial crisis have led banks to scale back lending and raised interest rates on loans.

That has made it more difficult for companies, especially smaller and medium-sized ones, to obtain credit to fund expansion or growth.

Mersch said the euro zone had started to recover and was reaching a point where companies could no longer rely on their own funds but were increasingly in need of external funding to keep growing.

"We are seeing tentative signs from survey data that credit demand in the euro area is starting to pick up," Mersch said in the text of a speech in Shanghai. "So we need to make sure that the banking sector is strong enough to meet that demand."

"A car can run on low fuel for a while, but at some point it needs to fill up otherwise the engine will stall. At this stage of the recovery it is clear: There needs to be sufficient fuel to rev up the engine," he said, referring to the signs of a pickup in credit demand.

Mersch said the ECB was counting on its ongoing health checks on lenders in the euro zone to help the banks clean up their balance sheets so that they can focus on lending.

The ECB has signaled its readiness to add more stimulus to the euro zone economy at its policy meeting in June if necessary and one of the tools on its shelf is an injection of cheap long-term funds with pricing linked to an increase in net lending.

Another option would be to cut interest rates, including the deposit rate, which currently stands at zero. A negative deposit rate would mean charging banks for parking their money at the ECB overnight.

This is seen as an incentive for banks to lend the money to other banks or companies and households instead.

Mersch did not single out any policy tools in his speech.

Reviving the market for securitized loans was particular important to improve funding for small and medium-sized companies, Mersch said, referring to a joint initiative on the matter with the Bank of England.

(Reporting by Pete Sweeney in Shanghai; Writing by Eva Taylor; Editing by Hugh Lawson)

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