Multiple bank regulators and risk taking

• Model of multiple regulators where agency bias can lead to a “race to the bottom”.
• Analyzes interaction of regulatory equilibrium and salient pre-crisis developments.
• Namely: rising bank leverage and increasing supervisional costs.
• Each raises bank risk on its own, but regulatory equilibrium acts as amplification.
• Extension to wholesale funding market: regulatory competition raises risk of freeze.

The potential for banks to arbitrage between regulators exists both in the US, with its multiple federal banking regulators, and in Europe, due to multinational banking. This paper models multiple regulators that have an agency bias, which can give rise to a “race to the bottom”. The model is used to analyze the interaction between the regulatory equilibrium and several salient pre-crisis features: rising bank leverage; wholesale funding with asymmetric information; and increasing supervisional costs to disentangling bank asset exposures. Each of these raises bank risk taking on its own, but regulatory competition is shown to be an amplification mechanism.