RWP 21-13, November 2021; updated September 2022
This paper presents a simple two-region banking model of liquidity mismatch to study the strategic interactions between national regulators. Banks hold insufficient liquidity, which leads to a fire-sale externality in an international financial market, justifying coordinated prudential liquidity regulation. However, joint regulation is not necessarily a Pareto improvement, as jurisdictions with a smaller banking sector have an incentive to free-ride on foreign regulation. Empirical evidence based on the implementation of the Basel II and III agreements supports this finding. If countries cannot agree on common standards, capital controls imposed on free-riders may improve the welfare of regulating economies and align the interest of free-riding countries with international regulation.
JEL Classifications: D62, F36, F42 G15, G21
Matschke, Johannes. 2022. “International Spillovers, Macroprudential Coordination, and Capital Controls.” Federal Reserve Bank of Kansas City, Research Working Paper no. 13, September. Available at External Linkhttps://doi.org/10.18651/RWP2021-13