Competition Among Regulators

IMF Working Papers, May 1, 2001

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The paper shows that competition among regulators reduces regulatory standards relative to a centralized solution.
A central regulator is more likely to emerge for homogeneous and financially integrated countries.
Regulators set their regulatory policy non-cooperatively while being concerned with their banking system’s stability and efficiency and with their banks’ profitability.
Externalities in bank regulation make the independent solution collectively inefficient.
These externalities and the benefits of centralized regulation increase with financial integration.
The costs associated with the loss of independence decrease with the homogeneity of the countries involved.

Framework: A formal model in which multiple national regulators choose regulation k non-cooperatively.
Objectives of each regulator: stability of the domestic banking system, efficiency, and banks’ profitability.
Externalities: Cross-border effects of national regulation create collective inefficiency under independent regulation.
Comparative statics: Financial integration amplifies externalities and the gains from centralization; greater country homogeneity reduces the political or economic costs of losing national independence.

Centralized regulation can lead to higher regulatory standards than decentralized, non-cooperative regulation.
Policymakers in regions with high financial integration should consider institutional arrangements that internalize cross-border externalities (i.e., centralized regulatory frameworks).
In negotiations over supranational regulatory authority, assessments should account for (a) degree of financial integration and (b) degree of homogeneity across countries, as these affect the net benefits of centralization.

Competition Among Regulators - WP/01/73
- Competition Among Regulators - WP/01/73 (Markdown version)
- Competition Among Regulators - WP/01/73 (PDF)