Financial integration and banking crisis. A critical analysis of restrictions on capital flows

Abstract

AbstractWe investigate the effect of financial integration on a banking crisis. In contrast to existing works, we allow for capital restrictions while studying the impact of financial integration on a banking crisis. Using firm‐level lending and borrowing information in the global market of syndicated loans; we generate aggregate measures of financial integration and examine how countries with capital flow restrictions thrive in the wake of a banking crisis. We concentrate on basic network measures of integration for a panel of 62 countries that allow for capital restriction at any time within the sample period. Financial integration increases the incidence of a banking crisis, and capital restrictions worsen a banking crisis. However, capital restrictions reduce the negative impact of financial integration on the incidence of a banking crisis. Thus, financial integration becomes beneficial when countries allow for some forms of capital control.