6 Financial Integration and Stability in Europe

Question 1

Financial Stability definition

Answer 1

Monetary stability is defined as the stability in the general level of prices, or as an absence of inflation or deflation (Duisenberg, 2001)

Financial stability can be defined as a condition in which the financial system – which comprises financial intermediaries, markets and market infrastructures – is capable of withstanding shocks and the unravelling of financial imbalances (ECB)

Question 2

Potential sources of risk to Financial Stability

Answer 2

Macroeconomic: Economic-environment risk, policy imbalances or political, large business failures
Financial markets: Counterparty risk, asset-price misalignment, run on markets, contagion
Financial Institutions: financial or operational risk,, reputation risk, business strategy risk
Financial Infrastructure: ClCleareance, payment and settlement risk, Infrastructure fragilities, collapse of confidence leading to runs

Question 3

The International Monetary Fund (IMF) soundness Indicators (Solidarität)

Answer 3

In the late 1990s, the International Monetary Fund (IMF) launched the Financial Soundness Indicators (FSIs) to monitor the soundness of the financial sector, from a macroprudential point
The global financial crisis that started in 2007–2008 revealed the need to revise the original list of FSIs and in 2019the Financial Soundness Indicators Compilation Guide (Guide) was presented
Includes new indicators to expand the coverage of the financial sector, including other financial intermediaries, money market funds, insurance corporations, pension funds, nonfinancial corporations, and households

Indicators: Capital Adequacy, Asset Quality, Earnings and Profitability, Liquidity, sensitivity to market risk, additional measures, other financial corporations (assets to gross domestic product (GDP), other financial corporations money market funds, pension funds, non financial Corporations, Households, Real estate markets,

Question 4

other stability measures

Answer 4

Firm-level stability measure: z-score
First-to-Default probability
Proposed as a measure of systemic risk for large financial institutions
Recognizes that defaults among a number of institutions can be connected
Systemic Expected Shortfall (SES)
Measures each institution’s individual contribution to systemic risk
Takes the individual taking leverage and risk-taking into account and measures the externalities from the banking sector to the real economy when these institutions fail
Is especially good at identifying which institutions are systemically relevant and would have the largest effects, if they fail, on the wider economy

Question 5

Defining Financial Integration

Answer 5

For the ECB, the market for a given set of financial instruments and/or services is fully integrated if all potential market participants with the same relevant characteristics:
Face a single set of rules
Have equal access to the above-mentioned set of financial instruments and/or services
Are treated equally when they are active in the market

Full integration requires:
Equal access to banks or trading, clearing and settlement platforms for both borrowers and lenders, regardless their country of origin
No discrimination among comparable market participants based solely on their location of origin

Question 6

Driving forces

Answer 6

more productive investment opportunities available, better relocation of funds, access to a broader range of financial instruments, more opportunities to diversify investment portfolios, firms can choose most efficient trading, clearing and settlement platforms, FI can exploit potential economies of scale and scope that a larger market can offers

Question 7

Collective action (DRIVING FORCE)

Answer 7

standard technical features of financial instruments, definition of common practices and conventions, reference indices (EURIBOR)

Question 8

Public authorities’ action

Answer 8

Establish appropriate legislative and regulatory framework
Catalyst or facilitator (help overcome co-ordination problems)
Examples:
The neutral ECB’s role in the fixing of the EONIA rate as a service to the banking sector
Regulation on cross-border euro payments

Question 9

Measuring Financial Integration

Answer 9

measure discrepancies in prices o returns on assets caused by geographic origin of the asset
- compare prices, CF in different countries
- price-based financial integration composite indicator (covers money, bond, equity, banking markets)
- Quantity-based measures (applied credit market and money market volume in different countries, measure home bias, covers interbank, bond and equity markets)
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