Carlos Canon Salazar, John Tasolis And Misa Tanak
Several global financial centres, including London, Hong Kong and Singapore, are overseen by financial regulators aimed at competitiveness and growth. recently Staff Working Paperdevelop a theoretical model to show that competitive deregulation can occur when several regulators are focusing on growth. To maintain the UK’s competitiveness and stability as a global financial centre, a comprehensive strategy that takes into account both regulatory and non-regulated measures is needed. This may require coordination between multiple agencies.
How much interest are financial regulators interested in growth?
Acquired in 2023 by the UK’s Prudential Regulatory Authority (PRA). Secondary competitiveness and growth targets To promote it, it is subject to international competitiveness of the UK economy (particularly the financial services sector) and medium and long-term growth, in line with relevant international standards. PRAs are not unique in having these growth goals. For example, the Singapore Financial Authorities (MAS) can be found. The purpose of the development is to expand Singapore into an internationally competitive financial centre. Similarly, Helping Hong Kong maintain its status as an international financial centre It is one of the important functions of the Hong Kong Monetary Authority (HKMA).
To measure the extent of regulatory growth focus, we conducted a textual analysis of the 2013-23 annual reports by the Federal Reserve Commission (Fed), European Banking Authority (EBA), MAS, HKMA and PRA to create a coarse measure of how often growth-oriented words are used compared to stability-oriented words. Based on this measure indexing the 2013 EBA level as 1, MAS and HKMA appear to be focusing more on growth than PRA, Fed and EBA over the past decade (Chart 1). Our scale also detects an increase in the growth focus of PRA in 2023 and is given secondary growth and competitiveness goals.
Chart 1: Growth Preferences – Cross Country Comparison, 2013–23
What happens when regulators compete?
What happens when some regulators have growth targets? To answer this question, we developed a game theory model. In our model, the regulators of two financial centres have an objective function consisting of a weighted sum of output from financial intermediation (the “growth target”) and the expected losses from bank failure (the “stability target”). Regulator 2 “growth-focused” weights higher growth targets than regulators “stability-focused”. The regulator sets the level of “regulatory strictness” (parameters) t In our model) to maximize objectives: this captures the infringement of supervisory surveillance and acceptability of various business models, as well as the complete package of regulatory and supervisory requirements, including capital and liquidity requirements. Increasing the level of regulatory strictness reduces the likelihood of bank failure, but also increases the cost of operating the bank.
Some banks are committed to operating in certain countries because they are attractive for non-regulatory reasons. In fact, the regulatory environment is just one of many factors that determines the ranking of a city. Global Financial Center Index 36Other factors such as taxation, availability of skilled workers, and infrastructure are also important. However, some other banks are willing to move their businesses to any country in response to the relative level of strictness of regulations. Banks can bluff and pretend to be mobile, so regulators can’t observe which banks are truly internationally mobile, so they respond by setting the same standard for all banks.
The level of regulatory strictness affects the growth of the model by affecting the number of banks attracted to the country. Second, these banks support increased commercial activity by matching international capital with productive investment opportunities. Internationally, mobile banks move to countries where the level of strictness of regulations is lower to allow them to maximize profits. However, there are strict levels where profits fall. Banks do not like regulatory strictness below this level, as they do not want to operate in insufficient and unstable environments.
As a benchmark, we will consider the following thought experiment: Suppose regulators are operating in a closed economy where banks cannot move abroad. In this case, the regulator will set the strictness of the regulations to maximize the expected profit per bank by comparing the expected output against the expected cost of failure. Move to core analysis and assume that regulators operate in an open economy where some banks can move overseas. Regulators are currently competing with each other, so they will set levels of regulatory strictness and also consider the impact on mobile bank attraction. If the settings are too high, there will be no mobile banks. Therefore, the expected output generated by the financial sector is low. But if the settings are too low, regulators will attract mobile banks, but only at the expense of increasing the failure rate for all banks. Therefore, the expected costs of bank failures could rise and the expected output could be lower.
The balance of the results is called “competitive deregulation.” This is a situation in which regulators may go below their closed economy optimal level, in order to attract mobile banks internationally. An extreme version of this is “race to the bottom,” which we define as a situation in which strictness of regulations is driven to the level that banks prefer. While competitive deregulation may occur, regulators have shown that if the expected costs of bank failure are high and the missions normally set by the government need to limit this cost, they will not compete to set regulatory strictness to a level where banks prioritize regulatory strictness.
What happens when a strong growth order is given by regulators?
The next step in the analysis is to ask how the level of financial regulation responds when governments revised their regulator’s mandate to focus on growth.
If growth-focused regulator 2 focuses on growth, competitive deregulation will be Reduced. This is because stability-focused regulator 1 expects rivals to compete more aggressively to secure all mobile banks, making them less willing to compete. Numerical simulations on Chart 2 show that the expected level of regulatory rigor provided by the two regulators (Y-axis) remains fairly stable as regulator 2 becomes more growth focused (as alpha-2 on the X-axis increases): initially increases gently, then decreases. This suggests that stronger growth delegations do not necessarily result in easing competition restraints.
Chart 2: The expected regulatory strictness is rather stable as growth-focused regulators become more focused
However, if stability-focused regulator 1 focuses more on growth, it results from competitive deregulation. Regulator 1 competes more aggressively and lowers the average level of regulatory strictness. Growth-focused regulator 2 is at a low level of regulatory strictness to address this challenge. Thus, competitive deregulation will intensify and anticipated regulatory tensions will be reduced. The numerical simulation in Figure 3 shows that as regulator 1’s growth focus becomes more pronounced (alpha 1 on the X-axis increases), it approaches that of regulator 2.
Chart 3: The expected regulatory strictness decreases as stability-focused regulators become more focused on growth
The regulator’s strategy also depends on the number of banks that rely on the relative strictness of financial regulations. This depends on non-regulated issues such as tax and labor laws that determine the attractiveness of the country. If more banks are mobile internationally, growth-focused regulators will attract them by lowering the strictness of regulations. However, the stability-focused regulator response is ambiguous as it weighs the advantages of attracting a larger pool of mobile banks to ease more regulations in order to compete with more aggressive rivals.
Global financial centres need comprehensive strategies to thrive
Our analysis has many policy implications. First, setting global regulatory standards can help limit the degree of competitive deregulation. However, in practice, it is not always possible to agree and implement global standards across all dimensions.
Second, setting hierarchical objectives (as in the UK PRA) where growth targets are strictly secondary to stability targets could be another way to limit competitive deregulation. To ensure stability objectives, regulators can monitor a set of quantitative indicators for key stability goals.
Finally, if financial regulators commit to staying in the country, as they are attractive in other dimensions, there is less need to use stricter regulations to attract financial institutions. This requires a comprehensive strategy that takes into account both regulatory and non-regulated measures to maintain both UK competitiveness and stability as a global financial centre.
With Carlos Canon Salazar Misa Tanaka Bank Research Hub and John Sanosorlis’ work are professors at Warwick University.
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