Regulatory arbitrage in action: evidence from banking flows and macroprudential policy

We use a new database on macroprudential policy actions to examine whether macroprudential regulations affect international banking flows. We find evidence that borrowing by the domestic non-bank sector from foreign banks increases after home authorities take a macroprudential capital action. We find no increase in borrowing from foreign banks after an action which tightens lending standards (such as limits on loan-to-value ratios for house purchase). Evidence on reserve requirements is mixed. Differences in the application of regulation for lending standards and capital regulation for international banks mean that while there is a level playing field for lending standards regulation, this does not always apply for capital regulation, giving foreign branches regulated by their home authorities a competitive advantage. Our results are, at first sight, different from the literature on regulatory arbitrage: we find that foreign banks expand their lending into host countries where regulation is tightened. But this does not occur when regulations apply also to them. The results have implications for macroprudential instrument choice and calibration, and for reciprocating regulation internationally.