All the earnest talk of the numerous legal and operational complexities of establishing a European banking union first announced amid great fanfare in June 2102, to be up and running at the start of 2013, but now unlikely to be effective before 2014 is that it draws attention away from the reality that national regulators are quietly applying an alternative remedy to the risks of bank deleveraging and credit shortages. Instead of uniting the European banking system in pursuit of the greater good, they are Balkanizing it, out of urgent and narrow self-interest. At a British Bankers' Association (BBA) meeting last month, Sir John Peace, chairman of Standard Chartered, drew attention to the danger. If there is a real threat out there it is financial protectionism, he said. By continuing to worry about derisking the system we run the risk of inadvertently slipping into financial protectionism. Bankers are growing anxious. There is a clear trend to require banks to separately capitalize and fund their national operations, says a European banker. But you cant have a monetary union with capital controls. Thats just incoherent. And when you have companies in Italy paying a much higher borrowing cost than similar companies in the same sectors just across the border in Austria, thats hugely anti-competitive in a so-called single market. An American banker in Europe adds: When youve been through a crisis, like Europe is going through, it is not far from a conflict. And in that situation, you look after your own first. This was clearly uppermost in the thinking of Mario Draghi at the end of July when he identified to a global investment conference in London a thorny collective action problem, where national supervisors, looking at the crisis, have asked their banks, the banks under their supervision, to withdraw their activities within national boundaries. And they ring-fenced liquidity positions so liquidity cant flow even across the same holding group because the financial sector supervisors are saying 'no'. In a report last month on continuing pressures on banks to delever, analysts at Barclays listed some of the most widely talked about examples of this trend. One motive for UniCredit to brave the unwelcoming equity capital markets for a rights issue at the start of this year was that while the groups capital was adequate to meet regulatory requirements, that capital was not fungible. German regulators would not be happy if an excess of capital in Germany was allocated to shore up balance-sheet problems in Italy. And there are any number of similar examples that other bankers mention: French banks being pressured by domestic regulators to reduce funding lines to their Italian and other peripheral European operations, for example. The Barclays analysts, led by Simon Samuels, report that: Worryingly, balkanization once started can be difficult to stop. If a regulator thinks that foreign regulators will limit cross-border balance-sheet transfers from international banks, they may be more likely to become more defensive themselves to prevent the capital/funding of their banks getting trapped abroad. That is a big problem in a region where banks are responsible for over 70% of credit provision to corporates. In September and October, some European banks showed that, for now, they have regained access to funding in the wholesale markets, but Paul Young, head of EMEA debt capital markets and Syndicate at Citi, says: it is difficult to see even the top-tier banks continue to fund efficiently at 300bp or more for long periods given the returns that they can generate on the asset side. Some banks do not have meaningful term market access to senior funding and we remain in an environment where there are clear distinctions among haves and have-nots in the bank universe. Given these uncertainties, he advises policymakers to press ahead with banking union as a matter of urgency. But all the high-flown talk of a banking union has not improved access to funding for small and medium sized corporations. Benoit Coeré, member of the executive board of the ECB, in a speech in Frankfurt last month, reported: The coefficient of variation across euro-area countries of the short-term cost of borrowing for non-financial corporations has been increasing towards all-time highs. For more on how balkanization threatens to torpedo the ECB's monetary policy, exacerbate the credit crunch and throw the Basel agenda into disarray, read Euromoneys November edition.