Supervising cross-border banks: Theory, evidence and policy

This paper analyses the distortions that banks' cross‐border activities, such as foreign assets, deposits and equity, can introduce into regulatory interventions. 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. Empirical analysis using bank‐level data from the recent crisis provides 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. We discuss several implications for the supervision of cross‐border banks in Europe.