Bank Supervision Going Global? A Cost-Benefit Analysis (Replaced by EBC DP 2012-015)

This paper analyzes the distortions that banks’ cross-border activities, such as foreign assets, deposits and equity, can introduce in the regulatory process. We find that while each individual dimension of cross-border activities distorts the incentives of a domestic regulator, a balanced amount of cross-border activities does not necessarily cause inefficiencies, as the various distortions can offset each other. In the case of imbalanced cross-border activities, a supranational regulator can improve outcomes, if her realm matches the geographic activity of banks, her capacity of extracting information is not lower than that of national supervisors, and the available resolution techniques do not cause higher external costs than under national resolution. Results from a numerical simulation exercise and empirical analysis using bank-level data from the recent crisis provide support to our theoretical findings. Specifically, banks with a higher share of foreign deposits and assets and a lower foreign equity share were intervened at a more fragile state, reflecting the distorted incentives of national regulators.