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RWP 21-13, November 2021; updated August 2023

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 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. The framework eludes to several arrangements that could bring jurisdictions closer to the efficient outcome, if they cannot agree on common standards: partial global agreements, intermediate agreements among free-riders only, transfers, and capital controls imposed on free-riders. An empirical section demonstrates that key issues around the implementation of the Basel Agreements and the European Banking Union 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…