Cross-country spillovers from macroprudential regulation: Reciprocity and leakage

In a globally interconnected banking system, there can be spillovers from domestic macroprudential policies to foreign banks and vice versa, for example, through the presence of foreign branches in the domestic economy. The lack of reciprocity of some macroprudential instruments may result in an increase in bank flows to those banks with lower regulatory levels, a phenomenon known as “leakage.” This may decrease the effectiveness of macroprudential policies in the pursuit of financial stability. To explore this topic, I consider a two-country DSGE model with housing and credit constraints. Borrowers can choose whether to borrow from domestic or foreign banks. Macroprudential policies are conducted at a national level and are represented by a countercyclical rule on the loan-to-value ratio. Results show that when there are some sort of reciprocity agreements on macroprudential policies across countries, financial stability and welfare gains are larger than in a situation of non reciprocity. An optimal policy analysis shows that, in order to enhance the effectiveness of macroprudential policies, reciprocity mechanisms are desirable although the foreign macroprudential rule does not need to be as aggressive as the domestic one.