ABSTRACT
With the significant increase in foreign banks presence in Eastern Europe (EE), 1 interlinkages among Western and Eastern European banking systems have grown markedly. The entry of foreign intermediaries has brought important gains in terms of efficiency and diversification and, through increased access to cross-border financing, it has contributed to rapid financial deepening in EE. At the same time, large and growing international financial linkages have altered the nature of the stability risks faced by financial systems, raising susceptibility to contagion. Higher integration by EE countries into the broader European banking system and the strong presence of foreign players have increased host countries’ vulnerability to idiosyncratic shocks from abroad. Conversely, the increased importance of EE in large Western European banking groups’ portfolios has also heightened the risk of contagion for home countries. The recent global financial crisis has brought to the fore the risks associated with financial interconnectedness and the potential transmission of shocks across intermediaries, and banks with operations in EE have not escaped unscathed from occasional bouts of heightened volatility. 2
