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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. Douglas W. Diamond & Raghuram G. Rajan, 2005. "Liquidity Shortages and Banking Crises," Journal of Finance, American Finance Association, American Finance Association, vol. 60(2), pages 615-647, 04.
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  3. Freixas, Xavier & Parigi, Bruno M & Rochet, Jean-Charles, 2000. "Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 32(3), pages 611-38, August.
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  7. Jean-Charles Rochet & Jean Tirole, 1996. "Interbank lending and systemic risk," Proceedings, Board of Governors of the Federal Reserve System (U.S.), Board of Governors of the Federal Reserve System (U.S.), pages 733-765.
  8. Stulz, Rene M., 2005. "The Limits of Financial Globalization," Working Paper Series, Ohio State University, Charles A. Dice Center for Research in Financial Economics 2005-1, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
  9. Lieven Baele, 2004. "Measuring European Financial Integration," Oxford Review of Economic Policy, Oxford University Press, Oxford University Press, vol. 20(4), pages 509-530, Winter.
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  11. Franklin Allen & Douglas Gale, 1999. "Financial Contagion," Levine's Working Paper Archive 2092, David K. Levine.
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Cited by:
  1. Ongena, Steven & Popov, Alexander, 2010. "Interbank market integration, loan rates, and firm leverage," Working Paper Series, European Central Bank 1252, European Central Bank.
  2. 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.

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