Ireland could face a "lost decade" similar to that suffered by Japan in the 1990s if banks do not learn how to lend to "new, viable enterprises", the Central Bank's chief economist has warned.
A European banking union that "breaks the link" between banks and governments was the best way to get credit flowing into the economy, preventing a "lost decade" like the one that followed Japan's property bust in 1991, Lars Frisell said.
"Ireland's banks today face great economic uncertainty and pressure to deleverage that stifle their ability or willingness to supply the economy with credit at reasonable costs," the Swedish-born economist said during a speech in Luxembourg.
He made the comments at a conference hosted by the European Court of Justice.
The comments echo the findings of a survey of Irish small and medium-sized enterprise (SMEs) companies yesterday.
It found that just 4pc of SMEs thought the Government was doing enough to support lending to the sector, which is crucial to job creation.
Some 88pc of SME owners believe more could be done to get credit flowing, according to the survey by business lender Close Brothers.
The lack of credit flowing to SMEs has been hotly debated in recent months.
Banks say they are willing to lend and blame low demand from businesses.
Business leaders and politicians say the banks could do more.
In his speech, Mr Frisell backed the planned European banking union, saying it could end the situation where banks linked to a weakened state and states linked to weakened banks were dragging each other down.
"The mere suspicion that a state may not be able to meet its debt obligations – correctly or incorrectly – leads to higher bank risk, higher funding costs, more expensive credit to the real economy."
Irish banks churned out "a reckless flow of credit" to fuel the property bubble but were now unable or unwilling to lend, Mr Frisell said.
It leaves Ireland and other European countries facing a situation similar to that suffered by Japan during its "lost decade", he said.
The experience there was that "many of its banks failed to shift their credit supply to new, viable enterprises" after their property bust.
"States in this position are chasing their own tail," said Mr Frisell.
He said a banking union could act as a "circuit-breaker" that could meet banks' need for capital and liquidity without damaging governments' balance sheets.