Bad Sovereign or Bad Balance Sheets? Euro Area Interbank Fragmentation and Monetary Policy, 2011-15

Does the funding cost differential between peripheral and non-peripheral European banks reflect poor quality of banks’ assets (credit risk)? Or the quality of sovereign support in case of failure (sovereign-dependence risk)? Combining bank-to-bank loan data with supervisory information on banks’ cross-border exposures, we disentangle the role of sovereign-dependence risk and credit risk in the euro area interbank market fragmentation from 2011 to 2015. Before the announcement of OMTs, high non-performing loan ratios on the GIIPS portfolio hindered banks’ access to the interbank market and large sovereign bond holdings raised interbank rates. The OMT and TLTROs reduced both channels of fragmentation.