Bad Sovereign or Bad Balance Sheets? Euro Interbank Market Fragmentation and Monetary Policy, 2011-2015

We measure the relative role of sovereign-dependence risk and balance sheet (credit) risk in euro area interbank market fragmentation from 2011 to 2015. We combine bank-to-bank loan data with detailed supervisory information on banks' cross-border and cross-sector exposures. We study the impact of the credit risk on banks' balance sheets on their access to, and the price paid for, interbank liquidity, controlling for sovereign-dependence risk and lenders' liquidity shocks. We find that (i) high non-performing loan ratios on the GIIPS portfolio hinder banks' access to the interbank market throughout the sample period; (ii) large sovereign bond holdings are priced in interbank rates from mid-2011 until the announcement of the OMT; (iii) the OMT was successful in closing this channel of cross-border shock transmission; it reduced sovereign dependence and balance sheet fragmentation alike