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Welfare effects of financial integration

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  • Hartmann, Philipp
  • Grüner, Hans Peter
  • Fecht, Falko

Abstract

This paper compares four forms of inter-regional financial risk sharing: (i) segmentation, (ii) integration trough the secured interbank market, (iii) integration trough the unsecured interbank market, (iv) integration of retail markets. The secured interbank market is an optimal risk-sharing device when banks report liquidity needs truthfully. It allows diversification without the risk of cross-regional financial contagion. However, free-riding on the liquidity provision in this market restrains the achievable risk-sharing as the number of integrated regions increases. In too large an area this moral hazard problem becomes so severe that either unsecured interbank lending or, ultimately, the penetration of retail markets is preferable. Even though this deeper financial integration entails the risk of contagion it may be beneficial for large economic areas, because it can implement an efficient sharing of idiosyncratic regional shocks. Therefore, the enlargement of a monetary union, for example, extending the common interbank market might increase the benefits of also integrating retail banking markets through cross-border transactions or bank mergers. --

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Bibliographic Info

Paper provided by Deutsche Bundesbank, Research Centre in its series Discussion Paper Series 2: Banking and Financial Studies with number 2007,11.

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Date of creation: 2007
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Handle: RePEc:zbw:bubdp2:6154

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Keywords: Financial integration; interbank market; cross border lending; financial contagion;

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  1. Carletti, Elena & Hartmann, Philipp & Spagnolo, Giancarlo, 2005. "Bank Mergers, Competition and Liquidity," Working Paper Series 182, Sveriges Riksbank (Central Bank of Sweden).
  2. Xavier Freixas & Bruno M. Parigi & Jean-Charles Rochet, 2000. "Systemic risk, interbank relations, and liquidity provision by the central bank," Proceedings, Federal Reserve Bank of Cleveland, pages 611-640.
  3. Rene M. Stulz, 2005. "The Limits of Financial Globalization," NBER Working Papers 11070, National Bureau of Economic Research, Inc.
  4. Allen, Franklin & Gale, Douglas, 1998. "Financial Contagion," Working Papers 98-33, C.V. Starr Center for Applied Economics, New York University.
  5. Yaron Leitner, 2005. "Financial Networks: Contagion, Commitment, and Private Sector Bailouts," Journal of Finance, American Finance Association, vol. 60(6), pages 2925-2953, December.
  6. Douglas W. Diamond & Raghuram G. Rajan, 2003. "Liquidity Shortages and Banking Crises," NBER Working Papers 10071, National Bureau of Economic Research, Inc.
  7. Xavier Freixas & Cornelia Holthausen, 2001. "Interbank market integration under asymmetric information," Economics Working Papers 579, Department of Economics and Business, Universitat Pompeu Fabra.
  8. Rochet, Jean-Charles & Tirole, Jean, 1996. "Interbank Lending and Systemic Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 733-62, November.
  9. Bhattacharya, Sudipto & Fulghieri, Paolo, 1994. "Uncertain liquidity and interbank contracting," Economics Letters, Elsevier, vol. 44(3), pages 287-294.
  10. Hans Degryse & Steven Ongena, 2004. "The Impact of Technology and Regulation on the Geographical Scope of Banking," Center for Economic Studies - Discussion papers ces0408, Katholieke Universiteit Leuven, Centrum voor Economische Studiën.
  11. Jith Jayaratne & Philip E. Strahan, 1997. "The benefits of branching deregulation," Economic Policy Review, Federal Reserve Bank of New York, issue Dec, pages 13-29.
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Cited by:
  1. Mutu, Simona & Breşfelean, Vasile Paul & Göndör, Mihaela, 2011. "The impact of the financial crisis on the interbank money markets behavior. Evidence from several CEE transition economies," MPRA Paper 42102, University Library of Munich, Germany.
  2. Steven Ongena & Alexander Popov, 2010. "Interbank market integration, loan rates, and firm leverage," Working Paper Series 1252, European Central Bank.

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