Cross-border regulatory spillovers and macroprudential policy coordination

A core-periphery model with financial frictions, imperfect financial integration, and cross-border banking is used to assess the magnitude of regulatory spillovers and the gains from international macroprudential policy coordination. A core global bank lends to its affiliates in the periphery and banks in both regions are subject to risk-sensitive capital regulation. Following an expansionary monetary policy in the core, a countercyclical response in capital requirements induces the global bank to engage in regulatory arbitrage. The magnitude of the resulting cross-border capital flows depends on the degree of economies of scope in lending. Welfare gains associated with countercyclical capital buffers are calculated for three policy regimes: independent policies (Nash), coordination, and reciprocity---a regime in which capital ratios set in the core are imposed on branches operating in the periphery. If regulators set policies on the basis of a narrow financial stability mandate, and these policies are evaluated in terms of household welfare, reciprocity may perform better than Nash, and as well as coordination for all parties, when regulatory leakages are strong.