Fragmentation in global financial markets: good or bad for financial stability?

Focus

How does financial market fragmentation relate to financial stability? Does more fragmentation always imply less financial stability? Alternatively, might there be a trade-off between the two, with more fragmentation enhancing financial stability in some cases? Taking a cross-jurisdictional perspective, this paper reviews the literature with the aim of shedding light on the issue and making suggestions for further analysis.

Contribution

The paper sets out various definitions of fragmentation, distinguishing price-based measures - differences in the prices of equivalent assets across countries - and quantity-based measures - deviations from benchmarks in international investment positions. It considers four types of cause: natural barriers; market forces; policy actions and interventions other than financial regulatory actions; and, finally, regulations and their enforcement. Although difficult, empirical methods used in other contexts can help isolate the specific cause and its effects.

The costs and benefits of fragmentation are reviewed from a financial stability perspective, using examples from securities markets, international banking and asset prices. Policy actions at the global level typically mean fewer regulatory and institutional differences between countries. Hence, markets globally tend to converge towards uniformity and less fragmentation. Since financial regulation, even when aimed at greater financial stability, inherently introduces frictions and barriers, it can nevertheless lead to some fragmentation. Thus trade-offs could arise between financial stability and fragmentation.

Findings

The review suggests that reducing fragmentation and enhancing financial stability are, in general, highly likely to be complementary. Yet fragmentation is not necessarily harmful for financial stability. In specific cases, some degree of fragmentation can actually serve to enhance financial stability. To assess possible trade-offs requires the various causes of fragmentation to be identified, together with a rigorous cost-benefit analysis. Cooperation - global in nature, and involving both public and private actions - can help.

Abstract

The many regulatory reforms following the Great Financial Crisis of 2007-09 have most often been designed and adopted through an international cooperative process. As such, actions have tended to harmonise national approaches and diminish inconsistencies. Nevertheless, some market participants and policymakers have recently raised concerns over an unwanted and unnecessary degree of fragmentation in financial markets globally, with possibly adverse effects for financial stability. This paper reviews the degree of fragmentation in various markets and classifies its possible causes. It then reviews whether fragmentation is necessarily detrimental to financial stability, suggesting that, as is more likely, various trade-offs exist. To identify and assess the scope for Pareto improvements, it concludes by outlining areas for further analysis.

JEL codes: G15, F30, G11, G12.

Keywords: financial stability, fragmentation, segmentation, financial integration, regulation, international cooperation.