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Financial integration, specialization, and systemic risk

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

This paper studies the implications of cross-border financial integration for financial stability when banks' loan portfolios adjust endogenously. Banks can be subject to sectoral and aggregate domestic shocks. After integration they can share these risks in a complete interbank market. When banks have a comparative advantage in providing credit to certain industries, financial integration may induce banks to specialize in lending. An enhanced concentration in lending does not necessarily increase risk, because a well-functioning interbank market allows to achieve the necessary diversification. This greater need for risk sharing, though, increases the risk of cross-border contagion and the likelihood of widespread banking crises. However, even though integration increases the risk of contagion it improves welfare if it permits banks to realize specialization benefits.

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Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 88 (2012)
Issue (Month): 1 ()
Pages: 150-161

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Handle: RePEc:eee:inecon:v:88:y:2012:i:1:p:150-161
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505552

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