Institutions for Fiscal Stability

By any measure, financial integration is more advanced in Europe than in Asia. This paper inquires into the causes of these contrasting experiences and asks what they bode for the future. Our results suggest that the very different levels of economic development in Asia and Europe, along with other differences in regional circumstance that are largely predetermined from the point of view of policy (the distance between countries, whether they share a common language, and whether they share a land border), explain a good deal of the difference in financial integration between the two regions. The rest of the gap is explained by policy variables. Evidence that finance follows trade suggests that Asia is less financially integrated than Europe because it has done less to promote the growth of intra-regional trade. Our results also suggest that controls on capital account transactions can have a lingering effect on the volume of cross-border claims, and that their shadow is longest where those controls have been maintained for the greatest number of years. The underdevelopment of financial markets and institutions in some potential lending countries also appears to be an impediment to financial integration in Asia.

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