The Impact of Cross-Border Banking on Financial Stability

Abstract

The globalization of financial markets has ushered in an era of interconnectedness, where financial institutions increasingly operate across national borders. This phenomenon, known as cross-border banking, has both potential benefits and risks for financial stability. While it can enhance risk diversification and promote economic growth, it also poses challenges such as contagion effects and regulatory coordination issues. This study aims to comprehensively investigate the impact of cross-border banking on financial stability, particularly within the European Union (EU). By examining the costs and benefits, developing metrics to measure optimal integration, and applying these metrics to EU countries, this research seeks to provide policymakers and regulators with valuable insights into the management of cross-border banking activities. The study begins by analysing the costs and benefits of cross-border banking. While it can offer advantages like risk spreading and increased credit stability, it also introduces risks such as contagion and regulatory challenges. The research explores the interplay between these factors and their implications for financial stability. To quantify the optimal level of cross-border banking integration, the study develops forward-looking indicators. These metrics aim to measure the extent to which a country's banking system is integrated into international markets while minimizing risks. By applying these indicators to EU countries, the research identifies which countries are more susceptible to systemic risks and which ones demonstrate optimal practices. Furthermore, the study investigates the systemic risks associated with cross-border banking, particularly the risk of financial contagion. It examines how the interconnectedness of financial institutions can facilitate the spread of shocks across borders and explores the role of regulatory coordination in mitigating these risks. The research also evaluates the trade-off between cross-border banking integration and local financial stability. While integration can provide diversification benefits, it can also increase vulnerability to external shocks. The study seeks to determine the optimal level of integration that allows countries to benefit from international markets without compromising domestic stability. Finally, the study provides policy recommendations based on its findings. By identifying countries with imbalances or low diversification, the research offers guidance on how to improve financial stability through targeted interventions. The recommendations aim to enhance the resilience of cross-border banking systems and contribute to a more stable and efficient global financial landscape.