Download Article

RWP 21-13, November 2021; updated July 2024

This paper presents a simple N 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 regulation. However, countries with a smaller banking sector internalize less of the inefficiency and have an incentive to free-ride on foreign regulation. As a consequence, countries cannot agree on common regulatory standards. Further, small countries have a strictly positive marginal cost to regulate, which can also prevent coordination on non-harmonized standards. An empirical section demonstrates that key issues around the implementation of the Basel Agreements are consistent with the implications from the model.

JEL Classifications: D62, F36, F42 G15, G21

Article Citation

  • Matschke, Johannes. 2022. “International Financial Regulation: The Role of Banking Sector Sizes.” Federal Reserve Bank of Kansas City, Research Working Paper no. 21-13, September. Available at External Link


Johannes Matschke


Johannes Matschke is an economist in the Macroeconomics and Monetary Policy Division at the Federal Reserve Bank of Kansas City. He joined the Bank in 2021 after obtaining his Ph…