New European Central Bank powers to oversee euro zone banks will help restore confidence in the sector and revive interbank lending, its president, Mario Draghi, said on Monday.

European ministers clinched a deal last week to give the ECB powers to supervise the currency bloc's banks from March 2014, taking the first step in a new phase of integration to help underpin the euro.

"The single supervisory mechanism will contribute to restoring confidence in the banking sector across the euro area. It will help revive interbank lending and cross-border credit flows, with tangible effects for the real economy," Mario Draghi told the European Parliament's Economic and Monetary Affairs Committee.

Bank-to-bank lending has yet to recover from the onset of the global financial crisis in 2007, and many banks rely on the ECB for their liquidity needs while others hoard their cash rather than lend it on.

Although the ECB will only have automatic oversight of around 150 of the bloc's 6,000-odd banks, it will have the authority to intervene in smaller banks if there are signs of trouble.

Germany fought hard to constrain the ECB's scope so that it would not cover its savings banks.

Draghi said: "The national supervisors' role gets bigger as the banks get smaller, but all national supervisors will be subject to the single rulebook as regulated from the center. The ECB will retain power to call in any bank under its domain."

Once ECB supervision is in place, the euro zone's rescue fund - the European Stability Mechanism - will be allowed in principle to recapitalize banks directly.

For now, euro zone governments have had to shore up their banks, adding further to public debt and creating a vicious circle between weak banks and states.

"Combined with possible direct recapitalization of banks by the European Stability Mechanism and an envisaged single resolution mechanism, the single supervisory mechanism will go a long way towards breaking the vicious feedback loops between sovereigns and banks," Draghi said.

More profound mechanisms such as a resolution structure to wind up failing banks and a deposit guarantee fund are a long way from being implemented. Draghi said the ideal scenario would have had cross-border supervision and a resolution fund set up in tandem.

Both Draghi and his ECB Governing Council colleague Luc Coene dismissed critics who have questioned whether the central bank can hold its independent line on monetary policy while also looking out for the welfare of banks.

"At the end of the day the Governing Council will be accountable for the efficient conduct of both policies," Coene said in a speech in Brussels.

Draghi also said the medium-term outlook for the euro zone economy remained "challenging".

At its policy meeting earlier this month, the ECB forecast a bleak 2013 for the euro zone economy, which it said would probably shrink again. It left the door open to a further reduction in interest rates - already at a record low 0.75 percent - in the early months of next year.

"We expect domestic weakness to extend into next year with a very gradual recovery in the second half of the year," Draghi said.

The big question for the ECB in the early months of next year will be whether Spain asks for help from the ESM, after which the central bank could activate its bond-buying program, the promise of which has gone a long way to calming the furor surrounding the euro zone.

Draghi said it was not up to the ECB to encourage governments to trigger the program.

(Additional reporting by Paul Carrel and Eva Kuehnen in Frankfurt, Ben Deighton in Brussels. Writing by Mike Peacock. Editing by Jeremy Gaunt.)