In the Shadow of Basel: How Competitive Politics Bred the Crisis

Abstract

What if global governance mechanisms undermine the capacity of national banking regulators to deal with the deviant activities of their banks? Such was the case, this paper argues with respect to the Basel Accords and the regulation of the bank-based shadow-banking system. Securitizationactivities by banks, driven by regulatory arbitrage have been an integral part of the shadow banking sector and a central transmission mechanism during the financial crisis. They have been identified as problematic by the international regulatory community since 1999, motivating reforms in Basel 2. This paper investigates why, nevertheless, regulatory loopholes that allowed banks to engage in these activities without core capital charges persisted in almost all Western jurisdictions pre-crisis. It lays emphasis on the global nature of the securitization business in conjunction with its national regulation, and shows that these national regulations on the fringes of global banking regulation were driven by competitiveness concerns. The Basel Accords were central in this dynamic, as they guaranteed the global nature of this market and gave national banking regulators the leeway to exempt securitization-activities from global regulation. Rather than eliminating competitive inequity concerns, the Basel Accords channelled them to its fringes, where they introduced a regulatory race to the bottom.

Global Governance and Regulatory Failure

“…This strategy was, for example, the choice of East Asian emerging market regulators in implementing the Basel I Accord (Walter 2008, Chey 2013. Likewise, Thiemann's (2014) already cited study on the interaction between national accounting rules and banking laws on the one hand and transnational regulatory standards of the Basel I Accord on the other hand, has revealed how eight out of ten analysed OECD countries knowingly oversaw regulatory arbitrage strategies by banks in their jurisdictions. As we discussed before, Thiemann argues that regulators feared that global market reach would pull financial activity into other jurisdictions if the regulator were to push legislation or regulation beyond the perforated global Basel standards.…”

Asymmetric influence in global banking regulation

“…Recently, studies even claim that global governance 4 REVIEW OF INTERNATIONAL POLITICAL ECONOMY creates additional problems, rather than reducing the existing ones. Thiemann (2014) demonstrated that the Basel I Accord had loopholes which neglected the usage of special purpose vehicles (an instrument used to circumvent regulations). Yet, even though national regulators became aware of this, they refrained from filling these loopholes.…”

A Crisis of the Overcrowded Future: Shadow Banking and the Political Economy of Financial Innovation

“…Fourth and finally, the consensus view in the emergent economic and financial literature, and certainly in the policy debate on the origins of shadow banking, suggests that shadow banking is an outcome of regulatory arbitrage in the international finance (Thiemann 2014). In this framework, shadow banking operations offer 'alternative, unregulated means to traditional banking functions' (McIntire 2014: 6).…”