Supranational Cooperation and Regulatory Arbitrage

Abstract

Using data on 113 banking groups, spanning 116 host and 40 home countries, we find that crossborder banks increase lending in a foreign subsidiary when the degree to which their other (foreign) subsidiaries are covered by supervisory cooperation agreements increases. This increase is funded by debt and does not improve profitability, suggesting higher risk-taking. The increase is stronger when supervisory oversight and market discipline in the subsidiary country are weak. Our results are confirmed by syndicated loan data and suggest that supervisory cooperation agreements have negative externalities on third countries, undermining overall effectiveness, and a need to "cooperate on cooperation".

Keywords: cross-border banking, Externalities, supranational cooperation

JEL Classification: G1, G2