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
JEL(s): G1, G2
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".