DP8854 Financial Integration, Specialization, and Systemic Risk
Author(s): | Falko Fecht, Hans Peter Grüner, Philipp Hartmann |
Publication Date: | February 2012 |
Keyword(s): | financial contagion, Financial integration, interbank market, risk sharing, specialization |
JEL(s): | D61, E44, G21 |
Programme Areas: | International Macroeconomics, Financial Economics |
Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=8854 |
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.