Euro zone banking at risk of dangerous fragmentation, ECB warns

FRANKFURT (Reuters) - Euro zone banks are turning away from cross-border activity, putting at risk the bloc's banking union and raising the risk of dangerous fragmentation, European Central Bank Vice President Luis de Guindos said on Thursday.

With national rules hindering cross-border consolidation, the euro zone bank sector remains highly fragmented, leaving lenders unable to compete with bigger and more efficient global peers.

Banks' excessive reliance on their home market also ties their fortunes to the local economy, maintaining a so-called 'doom loop' between banks and their sovereigns, a major vulnerability exposed during the bloc's debt crisis.

"Euro area-based banks have substantially reduced their cross-border claims since the crisis, and about 60% of banks' total exposures are to their home countries," de Guindos told a conference in Brussels.

"This is worrying at a time when the political momentum behind completing the banking union is fading," he added." This may lead banks to refocus their activities on their domestic markets as they anticipate that the banking union will remain incomplete, resulting in further fragmentation."

De Guindos said potential solutions could include the creation of a European safe asset, a proposal already put on the table by the bloc's risk watchdog but not discussed in substance due to German opposition.

Berlin fears that German taxpayers could be forced to pick up the cost of others' financial irresponsibility. This is also the basis of German resistance to creating a euro zone-wide deposit insurance scheme, which would also improve banks' cross border reach.

One option for a safe asset would be a synthetic bond, issued by a private investor and backed by the sovereign debt of each euro zone member. Such a construction would tie the bond to the performance of actual debt without putting any explicit legal burden on the governments that issue the underlying bond.

"If well-designed, such a European (safe) asset could become the benchmark for investors in EU capital markets, reduce the incentives for capital flight on national bonds within the euro area and contribute to lowering risks on banks' balance sheets," de Guindos said.

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