In the euro area, some heterogeneity in access to financing persists
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It is the European Central Bank that is in charge of monetary and price stability in the euro area. The powerful instruments it has at its disposal in times of crisis must therefore serve the interests of all countries and citizens—for whom the price of the consumer basket or borrowing conditions are closely linked to Frankfurt.
In response to the health crisis on 19 March 2020, the President of the European Central Bank, Christine Lagarde, announced the implementation of exceptional measures to address the crisis. The objectives were to maintain the supply of credit by avoiding cost distortions and to ensure the stability of long-term interest rates. More recently, in her speech in Frankfurt on 17 November, 2023, she stated that only deeper European financial integration would make it possible to face the challenges of deglobalization, demographics, and decarbonization, and warned against the "financial fragmentation" of the European economy.
Monetary Union: A common monetary policy and fully integrated markets
A monetary union, such as the euro since 1999, is defined as an economically integrated area: no barriers to the mobility of goods, services, capital, and workers between its member countries and a coordinated trade policy with the rest of the world. It is characterised by a single monetary policy, a single central bank and a single currency for all countries. Thus, perfect regional financial integration should homogenize investment opportunities and lead to increased cross-border financial links, better risk-sharing, and symmetry in exposure to frictions and common shocks for all countries in the union.
In the euro area, however, the effects of monetary policy do not appear to be entirely homogeneous. In particular, differences persist in access to financial services across countries, which raises the risk of "financial fragmentation." Several indicators measure this fragmentation, the best known and most commonly used being the "spread." It corresponds to the difference between the interest rate on eurozone government bonds and that on German government bonds, the benchmark country, for the same maturity and under similar conditions. A sharp widening of the spread can make a country vulnerable and raise the hypothesis of the risk of a sovereign debt crisis like the one from 2010 to 2012.
What are Frankfurt's levers to reduce this fragmentation in financial markets and the banking sector in order to increase the positive impact of monetary policy on household and corporate credit? A team of researchers investigated the impact of European monetary policies on this banking and financial fragmentation in the euro area in a study entitled “One size may not fit all: Financial fragmentation and European monetary policies” published in 2023 in the Review of International Economics.
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A powerful influence on the economy
The European Central Bank (ECB), created in 1998, has the main task of implementing the monetary policy of the euro area and maintaining price stability, with a medium-term inflation target of 2%. It implements its monetary policy according to the economic situation and intervenes, in particular in times of crisis or high inflation. Since 2013, as part of the creation of the European Banking Union, it has also been responsible for the prudential supervision of credit institutions in the eurozone. To achieve these objectives, the ECB has several instruments as its disposal, the most classic of them being the key interest rate.
The researchers analyzed data over 12 years—from the collapse of Lehman Brothers in 2008 until just before the health crisis in 2020. Since the subprime crisis of 2008, the European Central Bank has steadily lowered its key interest rate to stimulate growth. For about ten years, it was close to zero. Given the limited impact of this measure, the ECB has mobilized other economic policy instruments known as "unconventional." It improved its refinancing operations for the banking system with increasingly long maturities, measures called Credit Easing or Long-Term Refinancing Operations (LTRO). The aim is to provide banks with large volumes of liquidity at low interest rates for an extended period, typically several years, in order to support credit to households and businesses and thus growth.
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Then, in January 2015, at the height of the sovereign debt crisis, Frankfurt introduced a second unconventional tool: Quantitative Easing (QE). It consists of massive purchases of financial assets, mainly debt securities (bonds) of eurozone states, in order to inject liquidity and stimulate the economy. This policy aims to reduce long-term interest rates, particularly on government bonds, increase the money supply, and stimulate investment.
The analysis of the risk-taking associated with bank credit and sovereign debt within the eurozone reveals that the unconventional monetary policies implemented between 2013 and 2019 are perceived as a positive signal by the financial markets, thus helping to restore investor confidence. However, financial and banking integration within the euro area does not seem to have reached its pre-2007 crisis levels.
Too heterogeneous risk-taking
In their model, the researchers compare the impact of monetary policy instruments implemented between 2008 and 2020 on the reduction of financial and banking fragmentation in the eurozone. They introduce new indicators that complement the price dispersion measures generally used to assess fragmentation, with the aim of identifying the transmission channels of these policies at the eurozone level and in each country.
According to this model, LTROs and interest rates adjustments have positive effects mainly on the banking sector, while bond purchases (QE) increase confidence in the financial market. The combined impact of these measures reduce the disparity in borrowing rates between countries but has limited effect on the gap in the volume of credit available in the banking market within each country.
This latter effect can be explained by the heterogeneity in the "risk-taking channel," which corresponds to the degree of risk-taking by banks in each country. . In the eurozone, even if interest rates on loans converge, the volume of credit that banks make available to private borrowers remains unequal because macroprudential policies that regulate banks’ risk-taking are partly national. Another effect causing heterogeneity is that some banks prefer to use the liquidity provided by the ECB to buy dollar-denominated assets, which limits the positive impact of these measures on the credit supply of these banks to households and firms.
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How to reduce this heterogeneity?
A first, more cyclical lever is the ECB's decision to purchase sovereign debt in times of crisis. When it introduces Quantitative Easing (QE) in 2015, the European Central Bank purchased countries' debts based on each country's "capital key," i.e., each country's share in the ECB's capital. This meant that It was mainly German debt that was bought, even though Germany was one of the most resilient countries in the face of the crisis. During the health crisis, from March 2020, the ECB reinforced the measures already applied between 2009 and 2019, but in the framework of asset purchases on financial markets, it primarily targeted the countries most impacted by the crisis. For example, Italy, which was particularly affected, benefited especially from the European Central Bank's investment, which significantly contributes to reduce its spread.
From a more structural perspective, to address the issue of financial fragmentation in the euro area, the researchers suggest taking additional measures in regional banking regulation. They propose unifying national rules on borrowing conditions to limit distortions in the volume of credit available to households and firms across countries.
Finally, the Capital Markets Union project was proposed by former European Commission President Jean-Claude Juncker in 2014 as a common financial framework for all countries, alongside the banking union. It would allow countries and companies to benefit from the same financing opportunities in financial markets and reduce financial fragmentation by operating under the same financial laws. Ten years later, Mario Draghi, the former President of the European Central Bank, called for accelerating the process to face American and Chinese competitiveness and the major current and future energy and geopolitical challenges. The choices Europe will make in the coming years will be crucial in further strengthening citizens' confidence in the euro and establishing its position as a leader in the transition to a fairer and more sustainable world.
