THE EFFECT OF FINANCIAL INTEGRATION ON FINANCIAL DEVELOPMENT AND GROWTH: Pre-Crisis Assessment of the Euro Region

While it is evident that the integration that European countries are involved in through the European Union (EU) is beneficial in terms of labour and trade opportunities, the effect of such integration on financial development is unclear. This paper implements an innovative approach that examines the impact of financial integration on financial development, and subsequently on economic growth within a sample of EU countries, pre-financial crisis of 2008. Traditionally monetary depth measures are used to assess the size and development of the financial sector. However due to the centralized control of monetary policy, these monetary depth measures lose their effectiveness in assessing financial development within the EU. This paper therefore looks at bank-based measures of financial development in an effort to establish whether a relationship exists between financial development and growth in the European Union countries, and if so, whether this relationship has been affected by financial integration. The paper focuses on the time period before the 2008 financial crisis to avoid the impact of capital flight, failed banking sectors and budgetary issues. The results support the hypothesis that the benefits of economic and financial integration are not uniform. Financial integration does not seem to have a very significant effect on growth where financial development has been controlled for.