Financial integration, specialization and systemic risk Fecht, Falko

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Fecht, Falko
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Journal of International Economics
Banks and banking, International.; Banks (Finance); Bank loans
To link to full-text access for this article, visit this link: Byline: Falko Fecht, Hans Peter Gruner, Philipp Hartmann Keywords: Financial integration; Specialization; Interbank market; Financial contagion 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. Article History: Received 28 August 2009; Revised 22 November 2011; Accepted 24 January 2012 Article Note: (footnote) [star] We are grateful to Mark Flannery, Roman Inderst, Charles Kahn, Todd Keisters, Rafael Repullo, David Skeie, Roald Versteeg, and two anonymous referees for helpful comments. We also thank the participants of the 2006 BdE-CFS-ECB Conference on "Financial Integration and Stability" in Madrid, the ProBanker Symposium in Maastricht, the CEUS Workshop in Vallendar, the European Economic Associations Meeting in Budapest, the German Economic Association Meeting in Munich, the 10th Bundesbank Spring Conference "Central Banks and Globalisation" and the seminar participants at the Bank of England, the ECB, the Fed New York, the IWH in Halle, the University of Mannheim, the University of Mainz, de Nederlandsche Bank, and the Vrije Universiteit Amsterdam. The views expressed by the authors do not necessarily reect those of the European Central Bank, the Deutsche Bundesbank or the Eurosystem.
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