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Regulatory arbitrage and the efficiency of banking regulation
Institution:1. CREST, École Polytechnique, Université Paris-Saclay, Route de Saclay, 91128 Palaiseau, France;2. CREST, École Normale Supérieure Paris-Saclay, Avenue du président Wilson, 94235 Cachan cedex, France;1. Florida Atlantic University, Boca Raton, FL 33431, United States;2. University of Wisconsin-Milwaukee, Milwaukee, WI 53211, United States;3. U.S. Securities and Exchange Commission, Washington, D.C., 20549, United States;1. Cass Business School, London, United Kingdom;2. CEPR, United Kingdom;3. Bank for International Settlements, Basel, Switzerland;1. Stockholm University, 106 91 Stockholm, Sweden, and Research Institute of Industrial Economics, Box 55665, 112 15 Stockholm, Sweden;2. Saïd Business School, University of Oxford, Park End Street, Oxford OX1 1HP, UK;1. International Monetary Fund, Statistics Department, 1900 Pennsylvania Ave NW, 20431 USA;2. Department of Economics, Columbia University, 420 W. 118th Street, New York, NY 10027, United States;1. Federal Reserve Bank of Philadelphia, Ten Independence Mall, Philadelphia, PA 19106, USA;2. Board of Governors of the Federal Reserve System, 20th and C Street N.W., Washington, DC 20551, USA
Abstract:We study the efficiency of banking regulation under financial integration. Banks freely choose the jurisdiction where to locate their activities and have private information about their efficiency level. Regulators non-cooperatively offer any regulatory contract that satisfies information and participation constraints of banks. We show that the unique Nash equilibrium of the regulatory game is a simple pooling contract: financial integration is characterized by the inability for regulators to discriminate between banks with different efficiency levels. This result is driven by the endogenous restriction caused by regulatory arbitrage on the capacity of regulators to use several regulatory instruments.
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