According to Obstfeld (1986, ) there are two categories of measurement concepts based on financial market integration. The first category is based on the volume of transactions and the second category is based on the efficiency of the markets. A smaller degree of international financial transaction does not automatically imply market segmentation. It is possible that there will not be any stimulation for cross-border transactions exist because from the investor’s point of view domestic and foreign investment is equivalent. On the other hand, capital flow in connection with monetary and possible financial crises can hardly be seen as an indicator of a high level of integration.
The European Central Bank (ECB) had a clear impact on the banks’ role in the money market regarding the distribution of liquidity and determining the level of short-term interest rates. The ECB examined that the offered liquidity does not cover the all needs of a particular country. So, the liquidity must be in the secondary market. In the past 18 months, banks have effectively formed a two-sided system that larger institutions control the cross-border flow of liquidity and smaller institutions play a more restricted national role. Before this system occurred, large national banks were already making international transactions, while smaller ones were doing business transaction nationally. However, banks were generally not aware of the creditworthiness of the smaller banks in other countries. But it is clear that this situation puts the largest banks at an advantage. While performing an important function in distributing liquidity, they are able to profit from arbitrage opportunities, because liquidity shortages cause interest rate differentials between the EMU participant countries. So that the definition of financial market integration should include the possibility of cross-border transactions and investors’ willingness to enter into such transaction.
At first, the creation of a single currency and a single monetary policy was foreseen as a natural continuation of the birth of the single market which will make the freedom of movement of goods, services, labor and capital easier. But then, it turned into the single currency that helped the adjustments to the economy, economic policy and the adaptation of institutions. The introduction of the single monetary policy at the beginning of last year and converting to the Euro was a huge institutional and economic step. The currencies of the countries likely to be concentrated into the Euro-area accounted for around 30% of global foreign exchange market turnover. That market also covered ahead of turnover in the Yen (12%) but still significantly behind the Dollar (44%).
As seen in the graphs, this would make the Euro twice as important as the Yen, around half as important as Dollar. So, in terms of turnover, Euro looks like to become the second important currency worldwide.
While constructing a single monetary policy, the ECB took over responsibility for monetary policy from the national central banks. To show that whether the ECB is successful in conducting a single monetary policy, two criteria can be analyzed. First, the price of liquidity provided by the central bank and the price of redistributing that liquidity on the secondary market should be identical. Second, the procedures used to implement monetary policy should be equal across the Euro-area.
To examine developments in the segments of the Euro-zone money market, 3 common markets are important:
1) Unsecured credit market
2) Repo market
3) Swaps against foreign currency
Unsecured credit market: Overall growth in the unsecured market can mainly be positioned to the shortest maturities, particularly overnight transactions. In the longer maturities, turnover decreased effectively while trading volumes were very low. The increase in turnover in the unsecured market as a whole was a direct result of introducing the single currency to Euro-area. This unsecured credit market has shown a high degree of integration. Main reason for this is the efficient liquidity circulation and the triggered need of redistributing funds. Other evidence for market integration is the convergence of yields. Meantime, some mistakes of the ECB such as creating an excess or shortage of liquidity could signal inefficiencies in the market when redistributing liquidity.
Repo market: In contrast to the market for unsecured deposits, growth was not considered only in the shortest maturities. The relatively strong performance in the longer segments, when compared to unsecured transactions, is a result of a higher security provided by repo transactions. In addition to the integration of the Euro, the need of limiting credits could be applied to the developments in the repo market. Integration in the repo market has improved since the introduction of the Euro. To achieve a greater harmonization across the Euro-zone needs a deeper intervention and significant commitment by national authorities. The hierarchy for general collateral rates is among the factors pointing to a low degree of integration. Differences in the yields of the underlying bonds can mainly be positioned to different degree of liquidity.
Swaps against foreign currencies: Activity decreased in all maturities. the most important reason for this development is the disappearance of cross-currency trade among EMU participants. Though, turnover in currency swaps is about 23% of total market turnover. This amount is comparable in size to the repo market. A substantial share of currency swap transactions was cross-border.
CONCLUSION:
To sum up, the ECB has done a good job about liquidity management in the Euro-area. Its distribution of liquidity is an efficient work. In addition to this, the ECB is succeeding in conducting a single monetary policy. This is reflected in the equal costs of liquidity throughout the Euro-zone. The degree of integration differs among various segments of Euro money market. The unsecured market has quickly become highly integrated, while, the repo market remains domestically oriented.
References
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Swann, Dennis. The Single Europen Market and Beyond. London and New York: Routledge, 1992.
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Padoa-Schioppa, Tommaso. Domestic payments in Euroland: commercial and central bank money. 9 Nov. 2000. European Central Bank. 29 Nov. 2005. <>
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Herrmann, Sabine, Axel Jochem. The international integration of money markets in the central and East European accession countries: deviations from covered interest parity, capital controls and inefficiencies in the financial sector. March 2003. Bundesbank. 30 Nov. 2005. <>
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Schinasi, Garry. Euro at Five: Ready for a Global Role? 26 Feb. 2004. Institute for International Economics. 30 Nov. 2005. <http://www.iie.com/publications/papers/paper.cfm?ResearchID=509>
