Financial Integration, Specialization, and Systemic Risk
Frankfurt School of Finance & Management
H. P. Gruner
University of Mannheim - Department of Economics; Institute for the Study of Labor (IZA); Centre for Economic Policy Research (CEPR)
European Central Bank (ECB); Centre for Economic Policy Research (CEPR) - International Macroeconomics
CEPR Discussion Paper No. DP8854
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: 47
Keywords: financial contagion, Financial integration, interbank market, risk sharing, specialization
JEL Classification: D61, E44, G21working papers series
Date posted: March 1, 2012
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