Voluntary Support and Ring-Fencing in Cross-Border Banks

Abstract

We study supervisory interventions in cross-border banks under different institutional architectures in a model in which a bank may provide voluntary support to an impaired subsidiary using resources from a healthy subsidiary. While a supranational architecture permits voluntary support, a national architecture gives rise to inefficient ring-fencing of a healthy subsidiary when there is high correlation between the assets of the subsidiaries involved. The enhanced cross-subsidiary support allowed by a supranational architecture affects banks' risk-taking, leading to a convergence of the default risk among cross-border banks with heterogeneous fundamentals. Finally, a supranational architecture reduces the expected deposit insurance costs for banks with riskier fundamentals, but not for safer banks, even in situations in which it improves aggregate welfare.

Keywords: cross-border bank, supervisory intervention, supranational supervision, voluntary support, ring-fencing

JEL Classification: D8, G11, G2