The banking union and financial integration

In 2012, as a reaction to the eurodebt crisis, the governments of the euro area (EA) decided to establish a banking union. While primarily motivated by stability concerns (including the bank-sovereign doom loop and an intention to move from bail-outs to bail-ins), fostering financial integration was also an objective. How successful has the banking union been so far in fostering financial integration? What lessons can we draw from the banking union for the construction of a capital markets union? Brunella Bruno, Elena Carletti and I have addressed these two questions in a recent briefing paper for the European Parliament.

As Figure 1 shows, aggregate price- and quantity-based measures of financial integration have only partially increased since the inception of the banking union in 2014 (establishment of the Single Supervisory Mechanism), reaching levels similar to those observed after the start of economic and monetary union (EMU) in 1999. However, financial integration remains non-uniform across sectors and countries in Europe, with quantity indicators of cross-border exposures having increased, primarily due to interbank activities rather than retail lending or lending to large corporations. Conversely, price indicators show a reduction across the EA in dispersion in lending and deposit rates, indicating an increase in financial integration in the price dimension.

Figure 1: Financial integration indicators over the past 30 years

Source: ECB (2024)

Has the banking union contributed to financial integration?

On the positive side, the introduction of a single supervisor and a single rulebook has determined uniform rules across the EA and a more homogeneous implementation of local regulations, which helps to level the playing field. However, there are still two major obstacles to further financial integration. First, restrictions on capital and liquidity mobility imposed by local supervisors lead to inefficiencies in resource allocation by cross-border banks and higher costs of cross-border consolidation. Furthermore, the severity of the bank resolution framework in terms of bail-ins and the focus on liquidation rather than resolution limit its actual application and lead to divergent national practices, and so an uneven playing field. The second relevant barrier to both completing the banking union and achieving a truly integrated European banking market is national politics, which impede decisive steps toward harmonisation in several key policy areas (such as tax regimes and national legislation on competition, credit and consumer protection). Unless national governments are willing to take a backseat regarding their banking systems, only limited progress seems feasible. The current attempt by Unicredit to possibly takeover Commerzbank is certainly an important test case.

What lessons can be drawn for the capital markets union?

Even though incomplete, the experience with the banking union can provide some lessons for the capital markets union (CMU) project. The successes of the banking union in creating a single supervisor and in common rule-setting can provide a path forward for other sectors of the financial system. A stronger supranational supervisor and better coordination among European financial authorities are essential for the CMU. Harmonisation of relevant legislation is critical, as differences in insolvency laws, accounting practices and tax regimes continue to creating friction and impeding capital movement and investment diversification.  Having said that, the same national interests (even though not necessarily the same countries) that go against completing the banking union also provide barriers against integrating capital markets in Europe.

References

Beck, T., B. Bruno and E. Carletti, 2024. Can the Banking Union foster market integration, and what lessons does this hold for Capital Markets Union? Briefing paper for the ECON Committee at the European Parliament.

European Central Bank, 2024. Financial integration and structure in the Euro Area, June.