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interconnectedness

Has the Global Banking System Become More Fragile Over Time?

Asli Demirgüç-Kunt's picture

The last decade has seen a tremendous transformation in the global financial sector. Globalization, innovations in communications technology and de-regulation have led to significant growth of financial institutions around the world. These trends had positive economic benefits in the form of increased productivity, increased capital flows, lower borrowing costs, and better price discovery and risk diversification. But the same trends have also lead to greater linkages across financial institutions around the world as well as an increase in exposure of these institutions to common sources of risk. The recent financial crisis has demonstrated that financial institutions around the world are highly inter-connected and that vulnerabilities in one market can easily spread to other markets outside of national boundaries.

In a recent paper my co-author Deniz Anginer and I examine whether the global trends described above have led to an increase in co-dependence in default risk of commercial banks around the world. The growing expansion of financial institutions beyond national boundaries over the past decade has resulted in these institutions competing in increasingly similar markets, exposing them to common sources of market and credit risk. During the same period, rapid development of new financial instruments has created new channels of inter-dependency across these institutions. Both increased interconnections and common exposure to risk makes the banking sector more vulnerable to economic, liquidity and information shocks.

Cross-Border Banking Linkages: Good or Bad for Banking Stability?

Martin Cihak's picture

When a country’s banking sector becomes more linked to banks abroad, does it get more or less prone to a banking crisis? In other words, should cross-border banking linkages be welcomed? Or should they be approached with caution or perhaps even suppressed in some way?

The recent global financial crisis has illustrated quite dramatically that increased financial linkages across borders can have a ‘dark side’: they can make it easier for disruptions in one country to be transmitted to other countries and to mutate into systemic problems with global implications. 

But financial cross-border linkages may also benefit economies in various ways. They can provide new funding and investment opportunities, contributing to rapid economic growth, as witnessed in many countries in the early part of the 2000s. The more ‘dense’ linkages also provide a greater diversity of funding options, so when there are funding problems in one jurisdiction, there are potentially many ‘safety valves’ in terms of alternative funding.