Supervising Cross-Border Banks: Theory, Evidence and Policy

Abstract

This is the accepted version of the paper.This version of the publication may differ from the final published version. Permanent AbstractThis paper analyzes the distortions that banks' cross-border activities, such as foreign assets, deposits and equity, can introduce into regulatory interventions. We find that while each individual dimension of cross-border activities distorts the incentives of a domestic regulator, a balanced amount of cross-border activities does not necessarily cause inefficiencies, as the various distortions can offset each other. Empirical analysis using bank-level data from the recent crisis provides support to our theoretical findings. Specifically, banks with a higher share of foreign deposits and assets and a lower foreign equity share were intervened at a more fragile state, reflecting the distorted incentives of national regulators. We discuss several implications for the supervision of cross-border banks in Europe.

Should financial regulators engage in international policy coordination?

“…Beck et al (2013) evaluate this issue. The authors initially set up a simple closed-economy framework in which a regulator supervises banks with purely domestic operations with an exogenous probability of failure equal to 1−λ.…”

Bank Capital Regulation with Asymmetric Countries

“…Lax supervision, lax enforcement and bailouts give banks similar incentives to those under lax regulation and thereby render de jure capital regulation insufficient (Acharya, 2003). Consistent with Sinn's (2001) results and the presumption that national regulators have degrees of freedom when implementing Basel, Beck et al (2013) show that European and US regulators' decisions to enforce regulation (bank closure in their model) have in fact been distorted by the share of foreign equity, deposits and assets during the financial crisis.…”

Bank Resolution and the Structure of Global Banks

“…Another exception is Ervin (2017), who provides a quantitative analysis of the loss of diversification and greater risk of failure, for the same amount of aggregate capital, that results from the elimination of a flexible central capital reserve under MPOE resolution. Several related papers investigate other aspects of bank resolution: Jackson and Skeel (2012) and Skeel (2014) compare resolution under Dodd-Frank with the alternative of restructuring a failed G-SIB through bankruptcy; Duffie (2014) discusses the resolution of failing central counterparties, which, like G-SIBs, are likely to be too big to fail; Walther and White (2017) provide a model of bank resolution in which regulators may be too soft during a resolution, for fear of spooking market participants; and Beck, Todorov, and Wagner (2013) analyze how incentives for national regulators to intervene depend on foreign asset holdings and equity ownership of the bank in question. Colliard and Gromb (2018) study how bank resolution affects banks' incentives to privately restructure outside of resolution, whereas Segura and Vicente (2018) analyze the design of a public backstop in a banking union.…”