Financial integration and fragmentation in the euro area

The article examines developments in euro area cross-border capital flows, together with benchmark rates and bank lending rates, and shows that the process of financial integration among euro area countries over the first years of the monetary union went temporarily into reverse, starting in 2007 and intensifying after 2011. This development was characterised by an increasing home bias in the banking sector, a reversal of net capital flows within the euro area, and diverging interest rate developments across national borders. This fragmentation process creates distortions in the monetary policy transmission mechanism in the euro area and weakens the sustainability of the net external positions built up in the past. The article also presents the policy responses to deal with these developments, from the initial substitution of private by official cross-border capital flows and measures to restore monetary transmission in all market segments, to longer-term measures (e.g. banking union) that should contribute to a deeper and more robust form of financial integration in the euro area.