Working Paper: CEPR ID: DP8854
Authors: Falko Fecht; Hans Peter Grüner; Philipp Hartmann
Abstract: 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.
Keywords: Financial Contagion; Financial Integration; Interbank Market; Risk Sharing; Specialization
JEL Codes: D61; E44; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial integration (F30) | Bank specialization (G21) |
| Bank specialization (G21) | Welfare (I38) |
| Bank specialization (G21) | Systemic risk (E44) |
| Financial integration (F30) | Systemic risk (E44) |
| Interbank market reliance (F65) | Systemic crises (H12) |
| Sectoral shocks (F41) | Contagion (F65) |
| Contagion (F65) | Systemic risk (E44) |