Bank Capital Regulation with Asymmetric Countries

Abstract

When financial markets are global, the impacts of national banking regulations extend beyond national borders. While lax regulatory enforcement improves the profitability of home banks, it also increases loan supply, which in turn reduces the global interest rate spreads. In a two-country model we show that each regulator's enforcement choice is affected by the relative size of the national financial market. An authority regulating a smaller market has a smaller impact on global interest rates and therefore a stronger incentive to relax regulatory enforcement.

Should financial regulators engage in international policy coordination?

“…The analyses of both Bengui and Kara presume identical economies and regulator preferences, so their pro-coordination conclusions are not surprising in light of the discussion in Section 2 above. Eldridge et al (2012) also assume homogeneous preferences for national regulators but generalize the Dell' Ariccia-Marquez model by allowing for country size to vary. Eldridge et al argue that regulators in small countries know that the reactions of their client institutions to supervisory rules will have meager effects on global interest rates and hence are more likely to opt for lax supervision to benefit their domestic clients.…”

International cooperation on financial market regulation

“…However, their work mostly remains silent with respect to the requirements or conditions necessary to establish and sustain such cooperation. Eldridge et al (2015) extend the model of Dell'Ariccia and Marquez ( 2006) by assuming two countries that only differ in their market size. They find that smaller countries have a greater incentive for lax supervision.…”