Regulatory Arbitrage and International Bank Flows

Abstract

This working paper was written by Joel F. Houston (University of Florida), Chen Lin (The Chinese University of Hong Kong) and Yue Ma (Lingnan University).

We study whether cross-country differences in regulations have affected international bank flows. We find strong evidence that banks have transferred funds to markets with fewer regulations. This form of regulatory arbitrage suggests there may be a destructive “race to the bottom” in global regulations which restricts domestic regulators’ ability to limit bank risk-taking. However, we also find that the links between regulation differences and bank flows are significantly stronger if the recipient country is a developed country with strong property rights and creditor rights. This suggests that while differences in regulations have important influences, that without a strong institutional environment, lax regulations are not enough to encourage massive capital flows.