Working Paper: CEPR ID: DP7524
Authors: Itai Agur
Abstract: How damaging is competition between bank regulators? This paper models regulators that compete because they want to supervise more banks. Both banks' risk profiles and their access to wholesale funding are endogenous, leading to rich interactions. The sensitivity of regulatory standards to bank moral hazard, adverse selection, liquidity risk and the degree of regulatory bias is investigated. A calibration suggests that regulatory reform can halve bank default rates. The paper also shows how a decline in regulators' monitoring capacity gives rise to a gradual rise in bank risk, followed by a sudden interbank crisis.
Keywords: arbitrage; bank default; interbank market; moral hazard; supervision
JEL Codes: G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| regulatory competition (K20) | reduction in regulatory standards (L51) |
| reduction in regulatory standards (L51) | increase in bank risk (G21) |
| regulatory competition (K20) | increase in bank risk (G21) |
| increase in bank risk (G21) | higher bank default rates (G21) |
| decline in monitoring capacity among regulators (G18) | increase in bank risk (G21) |
| increase in bank risk (G21) | sudden crisis when interbank market fails (F65) |