Regulatory Arbitrage in Cross-Border Banking Mergers within the EU

Abstract

Banks are in the business of taking calculated risks. Expanding the geographic footprint of an organization’s profit-making activities changes the geographic pattern of its exposure to loss in ways that are hard for regulators and supervisors to observe. This paper tests and confirms the hypothesis that differences in the size and character of safety-net benefits that are available to banks in individual EU countries help to account for cross-border merger activity. The paper explains how this might have undermined regional stability. If they wish to protect EU taxpayers from potentially destabilizing regulatory arbitrage, central bankers need to develop statistical procedures for assessing the consequences of differences in supervisory strength and weakness in partner countries. We believe that the methods and models used here can help in this task.

Keywords: bank mergers, safety-net subsidies, cross-border banking

JEL Classification: F3,G2,K2