Working Paper: CEPR ID: DP16148
Authors: Saleem Bahaj; Frdric Malherbe
Abstract: We propose a model for studying the international collaboration of bank capital regulation under the principle of reciprocity. We show that such a regime makes countries strategically compete for scarce bank equity capital. Raising capital requirements in a country may generate bank capital outflows as well as inflows. We pin down the condition for the sign of the capital flow and the associated externality, and highlight the implications for macroprudential regulation. Compared to full collaboration, individual countries are likely to set Basel III's Counter-Cyclical Capital Buffer too high in normal times, and too low in bad times.
Keywords: Bank Capital Regulation; Reciprocity; Capital Flows; Macroprudential Regulation
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increase in capital requirements (G28) | changes in bank equity capital flows (F32) |
| increase in capital requirements (G28) | inflows of bank equity capital (O16) |
| increase in capital requirements (G28) | outflows of bank equity capital (F65) |
| changes in capital requirements (G28) | externalities on other countries (F69) |
| positive externality (D62) | regulators incentivized to undercut one another (D40) |
| negative externality (D62) | tighter regulations (G18) |
| capital requirements (G32) | strategic responses of regulators (G18) |