The European Central Bank (ECB) issued its annual report on financial integration in Europe. The report contributes to the advancement of the European financial integration process by analysing itsdevelopment and the related policies.
Namely, the market for a given set of financial instruments and/or services is fully integrated if all potential market participants with the same relevant characteristics: (1) face a single set of rules when they decide to deal with those financial instruments and/or services; (2) have equal access to the above-mentioned set of financial instruments and/or services; and (3) are treated equally when they are active in the market.
Financial integration fosters a smooth and balanced transmission of monetary policy throughout the euro area. In addition, it is relevant for financial stability and is one of the reasons behind the Eurosystem’s task of promoting well-functioning payment systems. The overall assessment of financial integration reveals that the aggregate post-crisis reintegration trend in the euro area resumed strongly in prices but not in quantities.
The resumption of the post-crisis prices reintegration trend was driven in particular by convergence in equity returns and, to a somewhat lesser extent, in bond yields. However, bank retail interest rates gradually ceased to contribute to this trend. Economic fundamentals are the main driver of this trend played a significant role in price-based convergence, as reflected for example in banks and non-financial corporations exhibiting less dispersed profitability prospects and credit risks.
In contrast, there was still no resumption of the post-crisis reintegration trend in quantities that had stalled in 2015. If anything, the quantity-based financial integration composite indicator has mildly declined since then although its latest reading is slightly higher than observed in last year’s report. This mild reduction over the past few years appears to result mainly from a lower share of cross-border interbank lending. While ECB monetary policy has supported money market integration, the ongoing injection of excess reserves – as expected – has reduced its counterparties’ needs to trade across borders within the euro area money market.
It is interesting to notice how investment funds tend to play a favourable role in quantity-based financial integration, because many of them are quite diversified and therefore can also help other investors to spread their asset holdings across countries. Given the increasing popularity of investment funds, this can make a material contribution to the quantity dimension of financial integration.
At the same time, the financial stability implications of such structural change need to be monitored. European firms are relying on corporate bonds for their financing more than in the past and both households and various financial intermediaries are increasingly holding corporate bonds via investment funds. This changing environment might entail new sources of risk as well as different transmission channels of financial instability. These need to be properly understood against the background of potentially stretched valuations in some bond market segments.