Financial Integration, Specialization and Systemic Risk
Frankfurt School of Finance & Management
Hans Peter Gruener
University of Mannheim
European Central Bank (ECB); Centre for Economic Policy Research (CEPR) - International Macroeconomics
February 13, 2012
ECB Working Paper No. 1425
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.
Number of Pages in PDF File: 49
Keywords: financial integration, specialization, interbank market, financial contagion
JEL Classification: D61, E44, G21working papers series
Date posted: February 21, 2012
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