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This paper investigates the role of banking networks in the transmission of shocks across borders.
Combining banking deregulation in the US with state-level idiosyncratic demand shocks, we show
that geographically diversified banks reallocate funds from economies experiencing negative shocks
to unaffected regions. Our findings indicate that in the presence of idiosyncratic shocks, financial
integration reduces business cycle comovement and synchronizes consumption patterns. Our findings
contribute to explaining the Great Moderation and provide empirical support for theories that predict
that banking integration facilitates the insurance of region-specific risk and the efficient allocation of
resources as markets become more complete.
