The Cross-border Effects of Bank Capital Regulation

Internal Seminar for Researchers

Abstract: We propose a model for studying the international coordination of bank capital regulation under the principle of reciprocity. In such a regime countries 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 collaboration, overshooting is likely: countries have an incentive to increase Basel III’s Counter-Cyclical Capital Buffer too much in good times and cut it too much in bad times.