DP16978 "Cooperation externalities": Supranational supervision and regulatory arbitrage
|Author(s):||Thorsten Beck, Consuelo Silva-Buston, Wolf Wagner|
|Publication Date:||January 2022|
|Date Revised:||July 2022|
|Keyword(s):||cross-border banking, Externalities, supranational cooperation|
|Programme Areas:||Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=16978|
Does supervisory cooperation among countries lead to risk-shifting within a banking group? Using hand-collected data on supervisory cooperation and 113 banking groups, we find that banking groups increase lending in a foreign subsidiary when the degree to which their other (foreign) subsidiaries are covered by cooperation agreements increases. The increase in lending is funded by debt and reduces profitability, suggesting higher risk-taking in the subsidiary. We show that the magnitude of the lending effect is higher when supervisory oversight and market discipline in the subsidiary country are weak relative to the other countries a bank group is operating in. Taken together, our results indicate that supervisory cooperation agreements have negative externalities on third countries, undermining their overall effectiveness and suggesting a need to "cooperate on cooperation".