DP16148 The Cross-border Effects of Bank Capital Regulation
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.