With respect to size, an overly large financial system could have negative effects on the functioning of the economy, either because it drains too many  1  I would like to thank Simone Manganelli for his valuable input. 2  Volckart, Oliver and Nikolaus Wolf (2006). Estimating Financial Integration in the Middle Ages: What can we learn from a TAR-model?, Journal of Economic History 66, 1, 122–139, Late medieval financial market integration: the Hanseatic Area, the Holy Roman Empire and the Kingdom of Poland, c. 1300–1550, research project proposal by O. Volckart, London School of Economics. BIS Review 81/2010  1  resources from other sectors, or because it increases the risks of bubbles. I will conclude with a few considerations on how the establishment of the European Systemic Risk Board can contribute to enhance the stability of our financial system. 1. Financial integration: an irreversible process  In my view, three elements constitute an integrated financial market: (i) a single set of rules, (ii) equal access to financial instruments or services, and (iii) equal treatment in operating in the market. If these conditions are satisfied, any price difference between assets with identical risk-return characteristics will be immediately arbitraged away. This definition stems from the intuition that lack of integration reflects the existence of barriers to cross-border activities. One can think of three main categories of obstacles to financial integration: cultural, legal and technical. Recent academic research has shown that there are non-negligible psychological and cultural barriers to financial integration.

Therefore, to improve financial stability by a lower degree of financial integration would certainly be the wrong measure. We should not undo those reforms which have paved the way to financial integration and revert back to a retrenchment within the national borders. This is certainly not the right strategy for the euro area, and it would be undesirable at global level. Admittedly, financial integration generates greater interconnectedness, which in turn may increase the risk that failure in one part of the system may trigger chain reactions in the formation of expectations which could have a destabilizing effect. But financial isolation – the opposite of financial integration – is not the rational answer to such a risk. We nowadays live in a global world, where not only financial, but also economic and cultural links have become increasingly tighter. News spread instantaneously and shape global market sentiments; products are designed, assembled and sold in different countries; political events in a small region can send shockwaves around the world. It would be naïve to think that a country could isolate itself financially. And even if it were possible, the costs in terms of lost efficiency and productivity would far outweigh any possible benefit. 2  BIS Review 81/2010  2. Financial development – opportunities and risks  If financial integration is both an irreversible process and a process we do not wish to reverse, finance per se is not always good in any form and size. This is where we can and should have a reasonable and fruitful discussion.