Abstract
Among the most notable results of the process of European economic consolidation, banking integration came to a stall with the beginning of the financial crisis in 2008. Since then European banks started cutting their international assets, reducing their exposure to European and international markets. This paper explores the link between the retrenchment in European financial markets and euro area fragmentation in the interest rate channel. The empirical analysis establishes two important results; first, financial integration measured via banks’ cross-country liabilities, is a significant (negative) determinant of fragmentation in the interest rate channel across euro area members; second, banks’ balance sheets differences matter in explaining cross-country financial fragmentation, as higher dispersion in banks’ equity ratios and liquidity are associated with higher wedges in interest rates passthrough.
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