How Regulatory Differences Become Banking Frictions

For the incomplete European Banking Union, the regulatory question is not whether Europe has one rulebook or none. It is whether differences that remain across national banking environments are associated with the missing foreign entries and bank-firm relationships identified earlier. This chapter explains how the paper measures those differences, what patterns it finds, and how to use the result without turning a strong correlation into a causal estimate of a reform.

Fragmentation has more than one regulatory source

A bank operating across countries faces several kinds of institutional exposure. Prudential rules affect how much capital and liquidity it must hold and how those requirements are applied across a group. Supervisory practices affect how rules are interpreted and monitored. Resolution arrangements determine how a failing bank is handled and which authorities control the process. Deposit-insurance systems shape the protection and funding of deposits. Entry and governance rules affect licensing, reporting, board responsibilities, and the organization of a local operation.

The paper also treats corporate bankruptcy as part of the banking environment. A bank lending to a firm cares about more than the contractual interest rate. It cares about what happens if the firm fails: how quickly a claim can be resolved, how much collateral can be recovered, and how predictable the process is. Two countries can share a currency and a high-level prudential framework while still giving lenders different expectations about losses and enforcement.

The distinction between a common rule and a common operating environment is important here. European legislation can set an anchor while leaving national authorities room to choose buffers, apply exemptions, exercise supervisory judgment, or organize deposit protection differently. A large banking group may therefore face one set of requirements at consolidated level and another set of practical obligations in a local entity. Even where formal rules are similar, the cost of learning how they are applied can remain country-specific.

The source gives concrete examples of the channels behind the aggregate categories. Macroprudential buffers can differ over time or apply to particular exposures. Options and discretions allow national authorities to depart from parts of a common rulebook. Liquidity and prudential waivers can change whether requirements are assessed at the solo or consolidated level. Deposit-guarantee systems differ in coverage, capitalization, funding, administration, and the role they play in a failure. These are not interchangeable rules, but each can change the cost or risk of serving borrowers across a border.

These domains are connected, but they are not identical. A difference in a capital buffer can raise the cost of deploying balance sheet. A difference in deposit protection can affect funding and the distribution of losses. A difference in bankruptcy practice can change expected recovery. A difference in supervision or governance can raise the fixed cost of learning how to operate. Each can make a foreign market less attractive without appearing as a separate fee on an individual loan.

This helps explain why major European reforms did not automatically eliminate fragmentation. The Single Supervisory Mechanism and Single Resolution Mechanism changed the institutional architecture, and European rules harmonized important parts of prudential regulation. But national discretion, implementation, deposit-insurance arrangements, entry procedures, governance requirements, and insolvency systems still shape the costs of operating across borders. Harmonization can narrow a gap without making every relevant condition identical.