Fragmentation in the European interbank market: Measures, determinants, and policy solutions

• This paper develops a new measure of fragmentation in the European interbank market.
• Fragmentation has been, on average, higher in the peripheral countries.
• High financing costs, counterparty risk, or debt-to-GDP increase fragmentation.
• An open and small banking sector and a good economic sentiment lower fragmentation.
• The SMP, 3Y-LTROs, Banking Union, and ECB President's speech reduced fragmentation.

This paper measures fragmentation in the European interbank market. We document that, during the recent crisis, fragmentation in the interbank market has been, on average, higher in the peripheral countries than in the core ones and it has increased particularly during periods of financial stress. Among the most significant factors that contributed to the high fragmentation levels observed are global factors such as financing costs and counterparty risk; and country-specific factors such as the debt-to-GDP ratio, the economic sentiment, and the banking sector openness. We also study the short-run effect of the ECB programmes and announcements and find a significant decrease in the daily levels of fragmentation immediately after the implementation of the SMP and the 3-year LTRO ECB programmes, the expansion of the list of the assets eligible as collateral in Eurosystem, the announcement of the Banking Union, and ECB President Mario Draghi's speech.