ABSTRACT
Structural changes in the economic environment, such as real synchronization of economies or advanced financial integration, affect economic agents and institutions (i.e. central banks, national governments and financial institutions) both individually and systematically. Integration can increase the investment opportunities of individual financial institutions, allowing them to make higher returns at the same level of risk. On the other hand, if individual financial institutions are exposed to the same risks, the risks of their portfolios as a whole are not necessarily diversified at all and the positive effect of market integration may thus be reduced. Identical risks arise because of, for example, the choice of a similar portfolio and/or the similarity of ‘aggregate’ risks. These risks are amplified by investors’ traditional search for yield. Moreover, the financial sector as a whole may be more vulnerable to systemic risk and contagion risk in conditions of high geographical and sectoral integration of the banking and other financial markets. Whether the benefits of deepening financial integration outweigh the risks, and whether this process will lead to increasing financial stability, depends largely on the resilience and flexibility of the financial system itself, which national and international authorities should be working to enhance.
