Bad Sovereign or Bad Balance Sheets? Euro Interbank Market Fragmentation and Monetary Policy, 2011-2015

Abstract

We measure the relative role of sovereign-dependence risk and balance sheet (credit) risk in euro area interbank market fragmentation from 2011 to 2015. We combine bankto-bank loan data with detailed supervisory information on banks' cross-border and crosssector exposures. We study the impact of the credit risk on banks' balance sheets on their access to, and the price paid for, interbank liquidity, controlling for sovereign-dependence risk and lenders' liquidity shocks. We find that (i) high non-performing loan ratios on the GIIPS portfolio hinder banks' access to the interbank market throughout the sample period; (ii) large sovereign bond holdings are priced in interbank rates from mid-2011 until the announcement of the OMT; (iii) the OMT was successful in closing this channel of cross-border shock transmission; it reduced sovereign-dependence and balance sheet fragmentation alike.

One size may not fit all: Financial fragmentation and European monetary policies

“…These countries have more vulnerable banking sectors with the lowest level of capital and the highest share of nonperforming loans (see Table A1). This result is in line with evidence presented in Altavilla et al (2020), Gabrieli and Labonne (2022), and Neuenkirch and Nöckel (2018). QE…”

“…Whereas the measures that concern lenders' behaviors (capital requirements or leverage ratios) are common to euro area countries and included in European directives (Capital requirement regulation [CRR]/capital requirement directive [CRD IV]), borrower‐based instruments (such as loans‐to‐value ratios or debt‐to‐income ratios) are left to national choices, creating heterogeneities in their implementation (Merler, 2015). The heterogeneity inside the Eurozone persists, with high levels of nonperforming loans (Table A1), insolvency (Table A3), and illiquidity risks in southern Europe (Tables A2 and A4), which limit the banks' access to the interbank market (Gabrieli & Labonne, 2022). Moreover, even if the risk associated with Eurozone sovereign and bank assets has decreased since 2013, the vicious circle between banks and sovereign risk remains (Colozza & Barucci, 2021).…”

Monetary Policy and Bank Stability: The Analytical Toolbox Reviewed

“…Indeed, Acharya et al (2016) show that, following the OMTs, individual banks' holdings of debt issued by stressed sovereigns have no bearing on their access to US MMF funding. In a similar vein, Gabrieli and Labonne (2018) show that before the OMTs banks were facing premia, when borrowing in the interbank market, that were related to the country in which they were based. Following the OMTs, these country-driven premia vanished and, instead, it is individual banks' balance sheet risk that determines the interest rate they are charged.…”

Bankruptcy Codes and Risk Sharing of Currency Unions

“…This assumption is based on the strong "home bias" of bank lending in the Eurozone widely documented in the empirical literature (see Acharya and Steffen 2015;Becker and Ivashina 2017;Gabrieli and Labonne 2018;Ongena et al 2018). It also reflects the doom-loop in the Eurozone à la and Farhi and Tirole (2017) that banks in the Eurozone hold a disproportionately large amount of national debt.…”