Effects Of Financial Integration Research Articles

Welfare implications of international financial integration

Focusing on technology spillover from foreign direct investment (FDI) inflows, this paper investigates the welfare implications of financial integration. Calibrations of a neoclassical growth model with international technology diffusion show that when technology catch-up due to FDI inflows is considered, the welfare gains from financial integration substantially increase, which contrasts with the small gains from additional, capital-accumulation effects of financial integration. The estimates suggest that by further enhancing financial integration, emerging Asian economies, such as the People's Republic of China (PRC) and the largest four Association of Southeast Asian Nations (ASEAN) countries, will experience substantial welfare gains.

Financial integration and growth — Why is Emerging Europe different?

Using industry-level data, this paper tries to explain why financial integration raised growth differentials between externally dependent and less dependent industries in European transition countries, but not in other developing or advanced countries in the years preceding the current crisis. We argue that political integration with countries that have stronger political and economic institutions leads to growth-enhancing foreign investments because investors expect an improvement of institutions in the future. The empirical evidence supports the importance of political integration: within the group of developing countries, the effect of financial integration is larger in countries that are more strongly politically integrated. Such an effect is not found for advanced countries. Our results suggest that political integration can considerably increase the benefits of financial integration in developing countries, even when institutions are still weak.

Global banks and crisis transmission

We study the effect of financial integration (through banks) on the transmission of international business cycles. In a sample of 18/20 developed countries between 1978 and 2009 we find that, in periods without financial crises, increases in bilateral banking linkages are associated with more divergent output cycles. This relation is significantly weaker during financial turmoil periods, suggesting that financial crises induce co-movement among more financially integrated countries. We also show that countries with stronger, direct and indirect, financial ties to the U.S. experienced more synchronized cycles with the U.S. during the recent 2007–2009 crisis. We then interpret these findings using a simple general equilibrium model of international business cycles with banks and shocks to banking activity. The model suggests that the relation between integration and synchronization depends on the type of shocks hitting the world economy, and that shocks to global banks played an important role in triggering and spreading the 2007–2009 crisis.

Financial Imbalances and Financial Fragility

This paper develops a general equilibrium model to analyze the link between financial imbalances and financial crises. The model features an interbank market subject to frictions and where two equilibria may (co-)exist. The normal times equilibrium is characterized by a deep market with highly leveraged banks. The crisis times equilibrium is characterized by bank deleveraging, a market run, and a liquidity trap. Crises occur when there is too much liquidity (savings) in the economy with respect to the number of (safe) investment opportunities. In effect, the economy is shown to have a limited liquidity absorption capacity, which depends - inter alia - on the productivity of the real sector, the ultimate borrower. I extend the model in order to analyze the effects of financial integration of an emerging and a developed country. I find results in line with the recent literature on global imbalances. Financial integration permits a more efficient allocation of savings worldwide in normal times. It also implies a current account deficit for the developed country. The current account deficit makes financial crises more likely when it exceeds the liquidity absorption capacity of the developed country. Thus, under some conditions - which this paper spells out - financial integration of emerging countries may increase the fragility of the international financial system. Implications of financial integration and global imbalances in terms of output, wealth distribution, welfare, and policy interventions are also discussed.

The Short and Long Run Benefits of Financial Integration

There is an extensive economics and finance literature that addresses the potential benefits of financial integration. Although theory predicts significant gains due to portfolio diversification, decreased cost of equity capital and reduced financing constraints, empirical models have so far yielded estimates of negligible welfare gains. Models used to estimate the welfare effects of financial integration do not explain both prices and quantities? In order to address this point, we propose a general equilibrium model that is able to simultaneously explain: (i) the volatility of exchange rate and stochastic discount factors; and both (ii) the volatility of net exports, and (iii) the amount of cross-country correlation and persistence of consumption growth rates. In our economy agents have risk sensitive preferences in the sense of Hansen and Sargent (1995). This implies that investors have a preference for the timing of the resolution of uncertainty. We conduct our analysis for the case in which consumption is a Cobb-Douglas aggregation of domestic and foreign goods, both of which are tradable. Furthermore we let the dynamics of the growth rate of the endowments of the two countries be characterized by the presence of two slowly moving predictive factors. These components, denoted as long run risks, alter the intertemporal distribution of income risk by producing slow swings in the The Short and Long Run Benefits of Financial Integration

Financial Regulation, Financial Globalization and the Synchronization of Economic Activity

We identify the effect of financial integration on international business cycle synchronization, by utilizing a confidential database on banks’ bilateral exposure and employing a country-pair panel instrumental variables approach. Countries that become more integrated over time have less synchronized growth patterns, conditional on global shocks and country-pair factors. To account for reverse causality and measurement error, we exploit variation in the transposition dates of financial legislation. We find that increases in financial integration stemming from regulatory harmonization policies are followed by more divergent cycles. Our results contrast with those of the previous studies which suffer from the standard identification problems. JEL Classification: E32, F15, F36, G21, G28, O16

Is Financial Integration a Complement or Substitute to Domestic Financial Development in a Developing Country? Evidence from the Sacu Countries

Using a multivariate cointegration and error correction modelling framework, with data from the SACU countries, this paper tested two rival theories on the effect of financial integration (FI), that is whether FI is a complement or a substitute to financial development (FD). Financial integration is a complement where it helps to boost domestic FD through greater competitive pressures on financial intermediaries, and encourage international good practices in accounting, financial regulation and supervision. It is a substitute where FI renders the local financial system irrelevant or causes it to deteriorate.Overall, the empirical analysis finds strong evidence of a long-run relationship between FD and FI across the SACU countries. The results show that causality runs in both directions between FD and FI across the SACU countries with the exception of Lesotho where the causality runs mainly from FI to FD. No consistent effect of FI on FD (or the reverse) emerged from the empirical results in this sample. The results were also affected by the measurements used for the capital stock and FD. These results do not support any onesize-fits-all policy approach to stimulating FD or harnessing the benefits of FI, rather, they suggest that country specific aspects of the financial system should be paramount when analysing the impact of FI on FD.

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Financial Integration and Business Cycle Synchronization

Standard theory predicts that financial integration leads to a lower degree of business cycle synchronization. Surprisingly, cross-country studies find the opposite. Our contribution is to document the theoretically predicted negative effect of financial integration on business cycle synchronization as a robust regularity. We use a confidential dataset on banks' international bilateral exposure over the past three decades in a panel of twenty developed countries. The rich panel structure allows us to control for time-invariant country-pair factors and global trends that affect both financial integration and business cycle patterns. In contrast to previous empirical work we find that a higher degree of financial integration is associated with less synchronized output cycles. We also employ two distinct instrumental variable approaches to identify the one-way effect of integration on synchronization. These specifications reveal that the component of banking integration predicted by legislative-regulatory harmonization policies and the nature of the bilateral exchange rate regime has a negative effect on output synchronization.

The Effects of Financial Integration on Structural Similarity: Consumption Risk-sharing and Specialization

Using panel data for 17 Organization for Economic Co-operation and Development (OECD) countries for the period 1983-2003, this paper investigates the effects of financial integration on specialization and international structural similarity. Theoretically, financial integration motivates countries to specialize on the basis of their comparative advantages and decreases the structural similarity between them. Our empirical analyses support the hypothesis.

Lessons from Financial Liberalisation in Scandinavia

The causes and consequences of the financial crises in the Nordic countries in the early 1990s are examined and lessons from this episode are extracted. The focus is on the boom–bust episode in Finland, Norway and Sweden as these three economies went into a deep recession. The lessons from the Scandinavian experience are organised under three headings: (i) how to liberalise without causing a boom–bust cycle, (ii) how to deal with a financial crisis, and (iii) the long-run effects of financial integration on stabilisation policies, growth and the distribution of income and wealth.

Financial integration, productivity and capital accumulation

Understanding the mechanism through which financial globalization affects economic performance is crucial for evaluating the costs and benefits of opening financial markets. This paper is a first attempt at disentangling the effects of financial integration on the two main determinants of economic performance: productivity (TFP) and investment. I provide empirical evidence from a sample of 70 countries observed between 1975 and 1999. The results for both de jure and de facto indicators suggest that financial integration has a positive direct effect on productivity, while it does not directly affect capital accumulation. I also control for indirect effects of financial globalization through financial development and banking and currency crises. While financial integration does not systematically increase domestic financial depth, it may raise the likelihood of banking crises, though only to a minor extent. Yet, the overall effect of financial liberalization remains positive for productivity and negligible for investment.

Financial Integration, Productivity and Capital Accumulation

Understanding the mechanism through which financial globalization affects economic performance is crucial for evaluating the costs and benefits of opening financial markets. This paper is a first attempt at disentangling the effects of financial integration on the two main determinants of economic performance: productivity (TFP) and investments. I provide empirical evidence from a sample of 93 countries observed between 1975 and 1999. The results suggest that financial integration has a positive direct effect on productivity, while it spurs capital accumulation only with some delay and indirectly, since capital follows the rise in productivity. I control for indirect effects of financial globalization through banking crises. Such episodes depress both investments and TFP, though they are triggered by financial integration only to a minor extent.

Integration of Financial Markets and National Price Levels: The Role of Exchange Rate Volatility

How does international financial integration affect national price levels? To analyze this question, this paper formulates a two-country open economy sticky-price model under either segmented or complete asset markets. It is shown that the effect of financial integration, i.e. moving from segmented to complete asset markets, is regime-dependent. Under managed exchange rates, financial integration raises the national price level. Under floating exchange rates, however, financial integration lowers national price levels. Thus, the paper proposes a novel argument to rationalize systematic deviations from PPP. Panel evidence for 54 countries supports the main findings. A 10% larger ratio of foreign assets and liabilities to GDP, our measure of international financial integration, increases the national price level by 0.27 percentage points under fixed and intermediate exchange rate regimes and lowers the price level by 0.3 percentage points under floating exchange rates.

Financial Integration and Firm Performance: Evidence from Foreign Bank Entry in Emerging Markets*

While the positive growth effects of financial integration are extensively documented, little is known of its impact on small and young firms. This paper aims to fill this void relying on a panel of 60,000 firm-year observations on listed and unlisted companies in Eastern European economies to assess the differential impact of foreign bank lending on firm growth and financing. Foreign lending stimulates growth in firm sales, assets, and use of financial debt even though the effect is dampened for small firms. More strikingly, young firms benefit most from foreign bank presence, while businesses connected to domestic banks or to the government suffer. Overall, our findings suggest that foreign banks can help to mitigate connected-lending problems and to improve capital allocation.

Financial Integration, Macroeconomic Volatility, and Welfare

This paper studies the effects of financial integration on macroeconomic volatility and welfare. We examine a two-sector (tradable and nontradable), twocountry world economy with production in which both stocks and bonds are traded internationally, but markets are incomplete. The effects of integration are examined by comparing the equilibrium properties of the model under three financial configurations: autarky, low integration and high integration. The model predicts a non-monotonic relationship between the degree of financial integration and the volatility of several macroeconomic variables. Greater integration is initially associated with more volatile consumption and output, but as integration proceeds further volatility declines. We also find that while increased integration allows for significantly greater risk-sharing between countries, the improvement in welfare can be very small.

Welfare Effects of Financial Integration

This paper compares four forms of inter-regional financial risk sharing: (i) segmentation, (ii) integration trough the secured interbank market, (ii) integration trough the unsecured interbank market, (iv) integration of retail markets. The secured interbank market is an optimal risk-sharing device when banks report liquidity needs truthfully. It allows diversification without the risk of cross-regional financial contagion. However, free-riding on the liquidity provision in this market restrains the achievable risk-sharing as the number of integrated regions increases. In too large an area this moral hazard problem becomes so severe that either unsecured interbank lending or, ultimately, the penetration of retail markets is preferable. Even though this deeper financial integration entails the risk of contagion it may be beneficial for large economic areas, because it can implement an efficient sharing of idiosyncratic regional shocks. Therefore, the enlargement of a monetary union, for example, extending the common interbank market might increase the benefits of also integrating retail banking markets through cross-border transactions or bank mergers. We discuss these results in the context of the ongoing debate on European financial integration and the removal of bank branching restrictions in the United States during the 1990s, and we derive implications for the relationship between financial integration and financial stability. Last we illustrate the scope for cross-regional risk sharing with data on non-performing loans for the European Union, Switzerland and the United States.

Financial Integration and Firm Performance: Evidence from Foreign Bank Entry in Emerging Markets

While the positive growth effects of financial integration are extensively documented, little is known of its impact on small and young firms. This paper aims to fill this void relying on a panel of 60,000 firm-year observations on listed and unlisted companies in Eastern European economies to assess the differential impact of foreign bank lending on firm growth and financing. Foreign lending stimulates growth in firm sales, assets, and use of financial debt even though the effect is dampened for small firms. More strikingly, young firms benefit most from foreign bank presence, while businesses connected to domestic banks or to the government suffer. Overall, our findings suggest that foreign banks can help to mitigate connected-lending problems and to improve capital allocation.

The real effects of financial integration

This paper shows how correlations in GDP fluctuations rise with financial integration. Finance serves to increase international correlations in both consumption and GDP fluctuations, which explains the persistent gap between the two in the data, a “quantity puzzle”. The positive association between financial integration and GDP correlation constitutes a puzzle, as theory suggests a negative relation if anything. Nevertheless, it prevails in the data even after the effects of finance on trade and specialization are accounted for.

The Real Effects of Financial Integration

Fluctuations in GDP are more synchronized internationally than fluctuations in Consumption, and they remain so even between financially integrated economies, where the ranking should in theory be the reverse. This paper shows this happens because correlations in GDP fluctuations rise with financial integration. Finance serves to increase international correlations in both consumption and GDP fluctuations, which explains the persistent gap between the two in the data. The positive association between financial integration and GDP correlation constitutes a puzzle, as theory suggests a negative relation if anything. Nevertheless, it prevails in the data even after the effects of finance on trade and specialization are accounted for.