The Effect of Banking Regulation on Cross-Border Lending

Banking regulations often differ between countries. For instance, some regulators oblige banks to document their evaluation of firms’ creditworthiness and thereby determine the banks’ lending technology. We study in a theoretical model how differences in regulation influence competition between domestic and foreign banks and the effect of regulatory harmonization on cross-border lending. We predict that lending rates are lower and Banking regulations often differ between countries. For instance, some regulators oblige banks to document their evaluation of firms’ creditworthiness and thereby determine the banks’ lending technology. We study in a theoretical model how differences in regulation influence competition between domestic and foreign banks and the effect of regulatory harmonization on cross-border lending. We predict that lending rates are lower and access to credit is easier for firms located in the border region if regulation differs. We confirm the model’s predictions using unique bank- and firm-level data from Germany by employing a difference-in-difference estimation.