While Europe has made progress toward the vision of an integrated financial market, its equity markets and regulation remain fragmented, which is undermining the region’s ability to reach its financial and economic potential, the European Central Bank (ECB) said in a report published Thursday.
In its latest report on financial integration — the degree to which Europe’s banking, bond and equity markets are functioning as a single unit, operating under common rules and providing equal access across the region — the ECB said that financial integration has improved “markedly” since 2022.
Nevertheless, it also concluded that the “euro area’s financial system continues to fall short of its potential to support long‑term growth, innovation and competitiveness.”
“External financing has remained subdued amid high interest rates and weak investment sentiment, while structural fragmentation continues to constrain equity market integration and the efficient allocation of savings across borders,” it said.
Against that backdrop, the report suggested that certain policy reforms are needed to enhance financial integration and unlock the full potential of a consolidated European financial market.
In the meantime, the ECB said its latest analysis found that since 2022, both price and quantity-based indicators of financial integration have improved and surpassed their historical averages.
“The improvement has been driven by key factors including a reduction in the risk premia associated with potential euro area disintegration and EU-level policy initiatives [aimed at enhancing integration and encouraging investment],” it said.
Among other things, the growing role of non-banks, such as investment funds and insurers, in financing the economy has facilitated integration through increased cross-border risk-sharing, and has further diversified the financial system, it noted.
The report said debt markets have made the most progress, benefiting from stronger cross-border growth in holdings of debt securities, including sovereign bonds. Interbank lending has also increased, but equity market integration has actually declined since 2022.
Alongside the weakness in cross‑border equity investment, foreign direct investment between Euro area countries also fell to historically low levels, the report said.
Moreover, European households continue to hold a large share of their financial assets in low-yielding bank deposits, rather than deploying them in equity markets, it said, adding that a large share of the equity investment that does happen is directed to foreign markets.
These factors are contributing to “a mismatch between the euro area’s high level of savings and its investment needs, limiting the availability of risk capital for innovative firms and weighing on long‑term competitiveness,” the report said.
Additionally, financial regulation remains fragmented across the region, the report noted, which produces “material differences in supervisory practices and enforcement outcomes.”
“This makes it harder for market participants to carry out cross-border activities, creates a non-level playing field and increases the risk of regulatory arbitrage,” it said.
As a result, the report calls for “targeted reforms to centralize supervision of large cross-border firms and inherently cross-border financial sectors” at the EU level, while also continuing to accommodate some local market oversight.
“Integrated supervision of EU capital markets and further progress on supervisory convergence are necessary steps to removing existing barriers to capital market integration,” it said.
The report added that more harmonized corporate tax rules could facilitate cross-border business, and that transparency in private markets should be improved.