Moreover, in the case of European banks, their return on equity is not only well below that seen prior to the crisis; their ROE is also lower than their cost of equity. Needless to say, this may have negative implications for financial stability. Put simply, low profitability limits banks’ capacity to generate capital buffers internally and therefore their ability to absorb negative shocks. At the same time, low returns may push entities towards risky search-for-yield strategies. My second message is that caution is required when drawing a simplistic and causal relationship between low profitability and monetary policy. Take for instance the case of Sweden, where the Riksbank has pursued a negative interest rate policy from 2015 until very recently; yet, banks’ profitability ratios in that country are relatively high. More broadly, low or even (mildly) negative interest rates tend to have counteracting effects on bank profitability: while they may exert downward pressure on unit intermediation margins, they 4  also promote loan demand, improve credit quality and produce capital gains in banks’ securities portfolios. We may well appreciate the different channels through which low (and even negative) interest rates help boost economic growth and repair banks’ balance sheets. But we cannot ignore the possibility that, if persistent enough, such a scenario may ultimately impair bank profitability and the bank-based transmission of monetary policy. Precisely for this reason, the ECB introduced last September a two-tier system for the remuneration of bank reserves.

The lack of specific alternative funding channels or sources can hinder investment particularly in higher-risk projects -startups, intangibles and innovation- which depend on venture capital or other specialised sources of market-based financing in their early stages. Small and medium-sized enterprises generally also encounter problems in tapping capital, owing to reduced access to market finance. There are several obstacles contributing to fragmentation. First, an investor seeking to diversify its portfolio by having exposures to companies in different countries must deal with legal barriers. The most telling example is the lack of harmonisation of insolvency regimes, which vary widely across jurisdictions for financial and non-financial corporations, as a result of different cultural traditions and legal frameworks. Second, this investor might face different regulations, as the process of strengthening the pan-European regulators is still incomplete. This is a more pressing question as markets become more integrated and technologically complex. Brexit entails a significant risk of further fragmentation, as some companies and transactions may relocate to several different financial centres, while others may remain in the UK. 11  Third, there are also inconsistencies in capital taxation. This is not only a problem of tax rates: tax bases are also different across countries, and there is enormous diversity and complexity in terms of legal requirements and forms, as in the case of withholding taxes. In addition, the so-called debt bias due to the favourable tax treatment of debt relative to equity distorts incentives in favour of the former.