While most analysts have been focused on credit growth, which has re-emerged after the sovereign debt crisis, cross border inter-bank lending has decreased. This development fragments the euro zone along national lines. In a crisis scenario, that fragmentation could increase dramatically, putting extra stress on national central banks and increasing financial fragility in the eurozone’s periphery.
According to figures published by the ECB, eurozone banks have cut lending to foreign peers over the past year, effectively beginning a re-nationalization of what is supposed to be a pan-European credit system. While cross-border interbank lending is down 6%, same country interbank lending is up 11%.
Why does this matter? Even as the eurozone economy has re-accelerated, the reduction in cross-border lending makes the banking sector more fragile. And we know that after the global financial crisis in 2008, that willingness of banks to lend across borders declined significantly – something that amplified crisis conditions in the banking systems starved of foreign credit. Now we are seeing the same thing happen within the eurozone. In the event that elections in the Netherlands, France, or Italy create financial turmoil, the balkanization of intra-eurozone lending will make the potential for a real crisis that much greater.