Despite the abundance of studies, the subject of financial integration continues to captivate the interest of scholars and policy-makers alike. If adequately facilitated, directed and managed, the rewards are likely to outweigh potential drawbacks. Some benefits include positive growth effects through financial development, efficiency gains from importation of technology and knowledge sharing, opportunities for risk diversification, increased effectiveness of monetary policy transmission through banking competition thereby lowering borrowing costs and stimulating investment. However, costs of financial integration can be large particularly when the necessary preconditions such as macroeconomic discipline, sound policies, quality institutions, adequate supervision and regulatory frameworks are weak. Financial and macroeconomic stability risks emanating from spillovers of global shocks to the domestic financial system with negative growth consequences have been argued as one of the crucial drawbacks of financial integration. That said, context and circumstances may also play important roles in deliberating on the desired and appropriate trajectory—should there be more integration or less integration. That very question, on the back of the aforesaid background, has encapsulated the minds of a key policy-maker in the South Pacific—a central bank.

This question can be answered adequately, however, with a sound understanding also of the extent and magnitude of financial integration in the region, which may also help better understand the likely consequences and provide a policy direction. The context and circumstances of the South Pacific region are unique, challenging and intriguing. Not only is the region made up of a number of small, open economies, most countries in turn are comprised of numerous islets. Moreover, growth, poverty, inequality and financial inclusion challenges pervade the entire region. Add to that backdrop the relatively shallow nature of financial markets, bank-centric systems, over-shadowed by foreign subsidiaries, the context and circumstances of largely import-dependent economies become even more intriguing and enthralling. What is the extent and magnitude of financial integration in the region—is it beneficial of harmful—would the region desire more or less integration? International banks do dominate the relatively small, bank-dependent financial systems. Among them, two Australian—Australia New Zealand Banking Corporation Limited (ANZ) and Westpac Banking Corporation limited (WBC)—among the oldest, and for over 150 years in the region. One would expect some form of integration in the banking systems. Australia, together with New Zealand and the United States, also are the main sources of tourism for the region—increasingly a major source of revenue. Plus, foreign direct investment, remittances, trade as well as technical and financial aid.

Results of a recent joint Griffith—Reserve Bank of Fiji study, covering the 1992-2016 period, show that in the long-run there is strong financial integration via the banking sectors within the Pacific Island countries (PICs), and the PICs are regionally integrated with Australia as well as globally (with the US). Fiji and Vanuatu seem to be the most integrated. The results are not surprising given a high level of trade, investment, tourism and other linkages as well as a very long and dominant presence of Australian banks in the region. In the short run, the countries are less integrated, and PNG seems to be the most influential as it influences all PICs and Fiji seems to be the least influential as it only affects Vanuatu. A policy-related question that emerges is: how can these linkages be converted into the rewards of integration—deepening and development of financial systems, efficiency gains and risk management?

This article is an edited version of a paper presented at the December 2018 South Pacific Central Banks—Griffith University inaugural research conference in Suva, stemming from one of the three research projects commenced during the 2018 Department of Foreign Affairs and Trade’s Australian Awards Fellowship program. The views and opinions expressed in this study are those of the authors and do not reflect those of the Reserve Bank of Fiji or its Board.