Financial integration generates benefits and costs for individual entities. In order to maximize the benefits and minimize the cost associated with the financial integration process, the details knowledge of these cost and benefits are needed. The importance of individual financial integration has increase due to the experience of the ongoing financial crisis. There are several benefits includes; (1) due to international diversification of risks, the consumption smoothing, (2) there are positive effect of capital flows on domestic investment and economic growth, (3) improving efficiency of the financial system and (4) increasing prudence of financial market agents and the attainment of a high level of financial stability. While the major costs includes: (1) insufficient access to funding at times of financial instability, including capital concentration and pro-cyclicality, (2) inappropriate allocation of capital flows, (3) loss of macroeconomic stability, (4) herd behavior among investors, financial contagion and high volatility of cross-border capital flows.
RELATIONSHIP BETWEEN FINANCIAL INTEGRATION AND GLOBALISATION
In studying the relationship between the financial integration and financial stability, the financial crisis has increased the interest of economist and regulators. An integrating market fosters financial stability by improving access to international capital markets and thereby increasing the opportunities for investors, creditors or debtors to diversify their investment risks. Besides that, the financial stability is aided by easier growth in the size of financial intermediaries. Larger institutions can better reap the benefits of an expanded and integrated market and can also better withstand potential shocks than institutions of local significance.
On the other hand, if the financial system is not sufficiently flexible, which are transmitted more rapidly through an integrated market, a strong integrated market does not foster financial stability. The more active the financial institutions are in the financial markets, the higher those institutions will be systemically relevant. Those institutions can definitely contribute to financial instability in the economy if they get into difficulties themselves. Moreover, if the amount and size of the institutions active in international market increases, the risk arising from their business will grow faster.
Economic and Financial Integration of CEECs: The Impact of Financial Instability
At the European Union (EU) level, the degree of economic and financial integration is of substantial interest to both academics and policymakers because of its implications on the economic efficiency and risk sharing. The recent priorities of EU policies have been to accelerate integration and to reduce transaction costs in financial markets.
The present financial crisis significantly affected the economies of these states and implicitly their integration process, situation which should cause the authorities to pay increased attention to the stability policy. Practically, the stability of the financial systems represents an element, which favours and ensures the sustainability of the integration process and mitigates at the same time the exposure of these countries to asymmetric shocks.
There are two category of criteria have been developed to evaluate the degree of economic and financial integration which are quantity based and price-based measures. The price-based measures used the concepts of beta-convergence and sigma-convergence. These concepts enable identification of the speed at which differences in yields are eliminated on individual financial markets. A negative beta coefficient signals the existence of convergence and the magnitude of the beta coefficient express the speed of convergence. The closer the value of the beta coefficient is to -1, the higher the speed of convergence. Both concepts must be tracked concurrently in order to assess financial integration.
How does a stable climate really favour the integration process and especially how does and instability period negatively affect the economic and financial integration process?
First, a stable financial system encourages the employment and the economic development. The important of this aspect was also noticed by the EU decision-makers who focused on macro-prudential measures to prevent the crises. Second, financial economic integration is achieved through capital flows and foreign direct investment flows. Stable exchange rate policies, low inflation and sustained growth influence the investment decisions. In a stable financial system, the credit policy sustains investment decisions and the regulation policies contribute to a sound banking sector which promotes financial integration. According to the financial stability theory, this "public good" can be ensured by ameliorating the institutional performance and the systematic risks monitoring and also by reducing financial system vulnerabilities. By obtaining an adequate level of financial system development or by securing financial institutions. The stability creates a favourable perception to investors and reflects the economy's capacity to function close to the optimal level. On the other side, an instable financial system does not have the necessary power to help the revival of the economic activity. Third, an important role in financial integration is played by the banking sector. The soundness of banks offers important information on the quality of the credit activity. Sound banking institutions enjoy good risk management skills and can also offer advises to their clients, upholding the investment process and the integration. In addition, an instable financial system is not capable of guaranteeing the commercial contracts nor does it facilitate he investments and the fulfillment of the monetary policy objectives.
Innovation and Integration in Financial Markets and the Implications for Financial Stability
IMPACT ON USERS OF FINANCIAL SERVICES
Financial innovation and globalosation have substantially increased the availability of credit to households and corporations and widened the menu of financial products to suit diverse demands. These changes have supported the growth the economic activity. The gains in financial system efficiency have lowered the cost of capital for firms and improved the ability of households to smooth their lifetime consumption and to insure against unexpected outcomes.
The increase in market access and in the breadth of borrowing options has delivered products better matched to customers' needs. There has been an increase in the availability of long-term debt, which may be more suited to the characteristics of corporate investment. Borrowing is readily available at both fixed and floating interest rates. Moreover, the ability of non-financial firms to manage their risks has been transformed by their increasing use of derivatives, particularly for managing interest rate and currency risk.
Households have also benefited from a wider range of mortgage and unsecured borrowing products. The recent growth of the fledgling house-price derivatives market suggests that ultimately households may be able to hedge housing risk. Of course, the increase in complexity of households' borrowing choices increases their exposure to new risks, placing a premium on financial advice and education.
In addition to an increase in borrowing options, there has also been an increase in credit availability which is reflecting a number of interrelated factors. First, the removal of quantity rationing. Second, the reduced cost of borrowing and third, the increase in risk-based pricing, which has supported the extention of credit to reach higher-risk customers and thus lowered constraints. The increasing range of options has enabled even small retail investors to develop more diversified, tailored and complex portfolios. In addition to the greater choices over investment and borrowing opportunities, households in many countries are becoming increasingly responsible for financing costs which were previously socialized and borne by governments.
IMPLICATIONS FOR THE FINANCIAL SYSTEM
The ability of financial firms to hedge and diversify exposures, as well as to transfer risks to other financial institutions or agents who are more willing or able to bear it, has transformed the way financial institutions manage risk in recent years.
A particularly important innovation has been the development of the credit derivatives market.
The use of options has also increased dramatically, with the BIS reporting that the notional value of contracts has increased almost five-fold since 1998. These contracts have enhanced financial institutions' ability to hedge complex risks and enabled users to take on (and protect themselves against) exposure to specific risks
The structure of the financial system is also changing. But the ability to securitise and hedge portfolios of loans has enabled two key functions of banks - the origination and holding of credit risk - to be separated.
Banks are taking advantage of the ability to separate the screening and monitoring of loans from the provision of term financing and moving more towards an 'originate and distribute' or 'arms-length financing' business model, whereby loans are originated and then repackaged and sold on as a security. This enables banks to maximize the value they can achieve from knowledge of borrowers' and lenders' needs through developing relationships, but at the same time economise on capital.
Credit risk can be dispersed amongst a wider range of investors, helping to reduce the concentration of exposure. Moreover, risk can be transferred to those with high tolerance or capacity to absorb it.
Thereby protecting the payments system from major credit shocks.
Increased use of securitisation as a funding source and risk management tool is also changing the nature of liquidity risks in the banking sector. Securitisation affects this vulnerability in a number of ways. First, the mismatch in maturity between assets and liabilities is lessened if long-dated assets are typically sold. Second, banks can now sell down loans they retain on their balance sheet if they come under pressure in normal market conditions. Third, banks can originate a large volume of loans from a given base of customer deposits and capital by turning over their balance sheet more quickly
The increase in institutions' and investors' cross-border activity is also leading to greater synchronisation and correlated movements across international markets. increased globalisation of markets has raised the scope for spillover and contagion between markets, reducing the benefits of diversification as market synchronisation has increased
