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Signature: Shail Patel Date: 03/04/2019

Degree: BSc (Hons) Investment and Financial Risk
Management
Cass Business School

Title: Regulatory Arbitrage:

Evidence through International claims
Name: Shail Patel

Supervisor’s name: Dr. Angela Gallo

Submission date: 3rd April 2019

"I certify that I have complied with the guidelines on plagiarism outlined in
the Course Handbook in the production of this dissertation and that it is my
own, unaided work".

Signature…………………………SHAIL PATEL………………………………………………….
Table of Contents

Abstract 3

Introduction 4

Literature Review 5

Empirical Methodology 6

Hypotheses 7

Data 8

Regression Model 9

Analysis and Regression Results 10

Conclusion 11

Bibliography 12

Appendices 13
Abstract

This paper analyses the effects of changes to capital requirements and reserve requirements on
international credit flow. Home-bias amongst banks has grown sharply, Bremus and Fratzscher
(2013). Our findings suggest that increase in capital requirements has encouraged domestic agents to
start borrowing from abroad. The same can be said for reserve requirements however they
sometimes tend to vary depending on a few other factors. We also find that increased stringency on
capital in a country results in increased capital outflow.

Key Words: Shadow banking, regulatory arbitrage, capital requirements, reserve requirements,
international claims, stringency, Basel I, II, III
Introduction

The global financial crisis uncovered a pattern in excessive risk taking and liquidity buffers within the
banking industry. It also revealed the defects in bank regulation and supervision. It’s been more than
a decade since the crisis, prudential policies have become an essential tool for central banks. These
instruments are used on a regular basis to tackle the issues that arise within the financial system, such
as cyclical or structural risks. Agents that are regulated would immediately reduce their risk-taking
activities in response to capital restrictions, on the other hand ‘unregulated’ agents take more risk, as
a result nullifying the effectiveness of the regulation. We call this regulatory arbitrage, this is when the
activities are still carried out but without being subjected to the regulation imposed by the policies.

The main problem, it is very difficult to measure bank regulation and supervision. There are numerous
laws from different national and domestic governments. Barth et al. (2013) created a database based
on the World Bank Surveys I – IV consisting of responses from more than 125 countries. However, we
have focused our final sample on 30 countries with the data ranging from 2005 to 2011.

Many have debated over the years on lending by ‘shadow banks’ or non-banking financial institutions,
in this paper we focus on the regulatory arbitrage generated by banks that are internationally active.
The prudential measures and supervision cannot be applied to every single financial institution within
the country as some prudential instruments in the absence of appropriate measures could have a
reverse effect (Reinhardt and Sowerbutts, 2015). The main reason for such uneven implementation of
policies is due to the legal structure, as foreign branches are not regulated in the same manner as the
banks that are domestically-regulated. Hence, we can expect that banks would expand their lending
activities as they won’t be subjected to the same restrictions (Bremus and Fratzscher, 2014).

Debates surrounding leakages has more focused on the non-bank financial institutions, leakages are
only important if they are a factor in the effectiveness of a new macro-prudential measure. What is
more interesting is the Basel III’s focus on Reciprocity on the countercyclical capital buffer. This means
that supervisory authorities in all countries will have to apply the buffer on their banks’ exposures,
once activated.

We find strong evidence that suggests that an increase in borrowing from foreign banks is encouraged
by an increase in capital requirements of the host country. The results obtained on reserve
requirement are better explained after the results have been discussed.
Literature Review

There are only a few papers that look at the empirical implications of imperfect bank capital regulation
with contribution to theoretical literature on international bank behaviour. We are already aware that
the theoretical literature suggests, raising capital is usually expensive and not having to raise capital
can be a competitive advantage. Secondly, replacing liquidity is also costly. However, foreign banks are
able to replace it from abroad more easily. Also, regulations affecting all banking institution should
have no relative effects (Reinhardt and Sowerbutts, 2015).

The Shadow banking system consists of a large number of specialized financial institutions that
facilitate the creation of credit without being subjected to regulation that traditional banks face.
Basically, the performing of unregulated activities by regulated institutions. In a traditional bank, a
single institution acts as an intermediary between depositors and borrowers. Banks engage in liquidity
transformation by funding loans with deposits. Credit transformation enhances the quality of debt
issued by this intermediary by using priority of claims. Maturity transformation occurs when an
institution uses short-term deposits to fund long-term loans, this creates liquidity for the depositor,
and it exposes the intermediary to duration risk (Adrian and Ashcraft, 2012).

In the build-up to the crisis, there was a prolonged period of increasing international financial claims.
The crisis however triggered a reversal of international funds, as banks started withdrawing from
foreign markets. The total international claims had substantially decreased in response to the crisis,
and the pre-crisis trend has not been seen since. Based on the findings of de Haas and van Lelyveld
(2004, 2006a), we know that distinction between the ‘push’ factor and ‘pull’ factor. These help explain
why the effects of the crisis have been heterogeneous across regions. Push factor deals with the
reaction to the home-country situation of the parent bank whilst the pull factor refers to the reduction
in credit by foreign banks in response to economic downturns and financial distress in the host country.
A positive push factor reveals that when the home-country is undergoing difficulties there will be a
contraction in the credit supply by foreign banks. A negative push factor shows that foreign entities
start lending even more during times of distress in the home-country.

Bruno and Shine (2013) have analysed the driving factors of international bank capital flows and they
concluded that bank leverage and the balance sheet capacity of banks plays a crucial role in driving
international bank flows. Based on the data collected from the Bank of International Settlements (BIS)
and the regulatory information from the World Bank survey I-III of Barth et al. (2008), Houston et al.
(2012) concluded that banks shift credit operations to countries with less strict regulation. In this paper
we will be using this information to provide evidence of regulatory arbitrage based on the changes in
regulation, focusing on the differences between the international claims pre, during and post crisis

Different jurisdictions have various rules and regulations across that dictate the amount and condition
of capital that banks are required to hold. The amount is calculated in terms of the ratio of capital
against total bank assets (Barth et al., 2013). However, there is a general trend we have noticed since
the crisis, almost all countries have improved their regulatory framework to better monitor the
activities within their banking industry.

Regulatory changes reflect that the higher the degree of independence in the source country the more
international transactions are performed. However, when taking push and pull factors into
consideration we find heterogeneity across different regions. There is heterogeneity even in the types
of securities, we know from Lane (2014) that debt funded flows were affected significantly more than
equity funded flows. In this paper, we look at various regions spread across the globe that were
affected by the changes in regulation in the country. Cetorelli and Goldberg (2011) show that
international lending to emerging markets was reduced during the crisis. This is an interesting point as
it encouraged us to investigate further to find if whether any heterogeneity existed based on the
regulation in the recipient country.

Literature published on motivation behind regulatory arbitrage tells us that the restrictions banks face
are probably the most influential factors, however there are a few other determinants. A big
determinant of the activities that motivate banks to perform regulatory arbitrage is the capacity of
their Balance Sheet (Bruno and Shin, 2013). As seen, there are various determinants to investigate but
in this paper we will focus solely on Capital and Reserve requirements and the Regulatory Standards
of various countries.

The purpose of this study is to compile this existing literature and study the policy drivers in
international lending by comparing their effects pre and post crisis. The hypotheses in the section
below explain in more detail the factors taken into account in order to conduct this research.

Empirical Methodology

First, we test whether or not domestic agents are encouraged to borrow from abroad if capital
requirements are tightened. There is evidence that has been presented by Aiyar et al. (2012) about
this effect in the UK. Through the use of bank-specific and time-varying capital requirements Aiyar et
al. (2012) are able to understand the effectiveness of macro-prudential changes in capital
requirements. Their measure of effectiveness was based on the literature partly suggested by Myers
and Majluf (1984), (i) relatively costly to raise capital, (ii) capital requirements must be enforced, and
(iii) leakages must not be able to fully offset the loan-supply effects of variation in capital requirements.

Secondly, we then perform another test to understand the significance of changes in reserve
requirements on domestic borrowers. Based on the known definition of reserve requirements we
clearly see that higher the requirements, more difficult it becomes for banks to lend. At this point they
might look abroad for funding, however there is the off chance that it might be costly. Here again our
dependent variable is going to be Changes in International Claims.

Important to note that Milesi-Ferretti and Tille (2011) found that during the financial crisis there was
a decline in international capital flows and that it depended on the region, the time-period and the
type of capital. They concluded that international lending has dropped significantly after the crisis,
however this is different to what we are trying to achieve through this paper. Here, we are testing
whether any policy or regulatory changes had a significant impact on domestic banks’ borrowing. To
understand this better we have divided the periods to clearly see the effect of the changes in the build-
up, during and after the crisis, hence we test for the period which is: Pre-crisis = Jan 2005 – Dec 2006,
and Post-crisis = Jan 2009 – Dec 2011

Finally, we build on the findings of Houston et al. (2012) who concluded that environments with
stringent requirements and regulations will encourage expansion ‘abroad’, i.e. in less regulated
markets. It is interesting to see the results of Houston et al. (2012) as they found statistics that showed,
a 1% change in the supervisory power could increase the chances of a bank opening a new branch
elsewhere by 10%. Based on their results, they were able to prove that regulatory arbitrage is taking
place.
Hypothesis

Hypothesis 1 – Domestic agents will borrow more from abroad if the capital requirements of domestic
banks are increased

The weighted average cost of capital increases when capital requirements are increased, however this
will not capture foreign branches and international lending. Based on the existing theoretical literature
we know that this gives the foreign branches and foreign banks undertaking international lending a
competitive advantage. There is already evidence for this effect in the UK, it was shown by Aiyar et al.
(2012).

Hypothesis 2 – Domestic agents will borrow more from abroad if the reserve requirements of domestic
banks are increased

Reserve requirements refer to the amount of deposits that a bank is obligated to hold as a reserve and
not lend out. This means that if the reserve requirements are increased then banks have less to lend,
meaning they need to find funding from abroad. Foreign banks on the other hand are left with an
advantage over the locally incorporated banks who will now borrow from these foreign banks
(Reinhardt and Sowerbutts, 2015).

Hypothesis 3 – Regulatory arbitrage shifts credit to countries with lenient regulatory standards

This is to understand changes in the international bank claims in the pre as well as post crisis period.
Houston et al. (2012) concluded that tighter regulation in the home-country encourages credit
outflows whereas tighter regulation in the destination country reduces credit inflows. Based on the
literature from Bernanke (2013) we know that banks are attracted by markets that yield higher returns,
meaning developing countries, emerging markets. Prior to that Fratzscher et al. (2012) found evidence
during their study on the impact of US monetary policy on international flows that US policies pushed
significant amounts of capital to developing markets.

Data

In this section, we explain the data collected for the purpose of this study.

Our hypotheses are encouraged by Reinhardt and Sowerbutts (2015), in their study they create a
completely new database on macroprudential policy, based on the sources such as Lim et al. (2011),
Borio and Shim (2007), and Kuttner and Shim (2013). Their focus on lending standards and the
inexistence of a near accurate database was the main reason for creating a new database. For our
study the indices we require are created and built by Barth et al. (2011).

Barth et al. (2011) were tasked with creating an index (first in the late 1990s) that could monitor bank
regulation and supervision, and with the use of World Bank Surveys they were able to create indicators
and indexes of important regulatory policies. In this paper, we are testing whether the changes in
regulation motivated domestic banks to start shifting credit to less regulated countries as found by
Houston et al. (2012), although they used dummy variables to account for foreign subsidiaries and
branches, and took into account the studies by Alfaro, Kalemi-Ozcan, and Volosovych (2008) and
Papaioannou (2009) on the importance of institutional quality in encouraging bank flows. We are
simply going to run an OLS regression to obtain an output of values that we expect to show effects of
changes in regulation of capital and reserve requirements on international claims.
In order to trace a country’s banks’ international lending, we collect the data on International Claims
at an immediate counter party basis from the Bank of International Settlements (BIS) Consolidated
banking Statistics, ranging from the start of 2005 till the end of 2011. This data is better suited for this
study than the international claims data on an immediate borrower basis. For the purpose of the study
I have selected 30 countries which include major financial markets and developing markets across
various continents. A list of the countries is provided in Appendix 1. Due to the difficulty in finding
monthly or quarterly data for many of the variables, we chose to take annual averages based on the
quarterly data of international claims.

In their paper, Bremus and Fratzscher (2014) used ‘stringency on bank capital regulation’, official
supervisory power, and the overall independence of banking supervisory authorities to understand the
effects of changes in banking regulation on international lending. However, they test their hypothesis
on whether increased regulation in the host country which in turn increases costs could make
international lending less attractive. We use the same indicators to test whether changes in regulatory
standards affects international bank flow. These are calculated based on the answers collected from
the World Bank Surveys detailed information is available in Appendix 5:

Official Supervisory Power: shows the extent to which a banking supervisory authority is able to
intervene and take measures to ensure stability.
Measure: 0 to 14, higher the value the stronger the regulatory power
Overall Supervisory Independence: measures the independence of the supervisory authority from the
government, the banking industry and political considerations.
Measure: 0 to 3
Overall Capital Stringency: gauges the extent to which capital regulation reflects risk elements and if
minimum capital adequacy is determined after market value losses are deducted.
Measure: 0 to 7
Tables 1 & 2 show descriptive statistics of the variable pre-crisis and post-crisis, using this we then go
on to compute gaps between the regulatory stance in the developed and developing countries. It is
just the simple difference between the regulatory variable in the two countries. If the gap is positive it
means that the developed country has a more stringent regulatory framework compared to the other
country, and is more likely to indulge in regulatory arbitrage. This is where we want to test whether
banks will shift credit abroad as this a huge motivating factor. We find that the official supervisory
power in developed countries has always been higher compared to the countries with developing
financial systems and they continued to expand after the crisis, previous underdeveloped or
developing countries also started implementing better regulatory framework to support supervisory
authorities in taking action whenever needed to ensure stability in the country’s economy. However,
they still lack behind due to the implementation period of these policies and the time need to actually
realize the effects of the policy. In terms of capital stringency we find that all countries regardless of
whether they are developed or not, had pushed to ensure better regulatory standards are in place
after the crisis. Hence, there is little difference between the two parties with regards to capital
stringency. Developing countries have matched the level of regulation implemented across developed
countries in order to better monitor bank activities and preventing runs.
As you can see in figure 1, foreign lending was increasing up until the crisis, after which we saw a
decrease in these activities, more notably in developed countries. This shows that banks shifted their
focus to their domestic markets and reduced the flow of money to foreign markets, especially
emerging markets. This was previously shown by Bremus and Fratzscher (2014), they presented
evidence that international claims within the Euro Area have reduced by approximately 50%. This also
sheds light on the conditions of credit markets post crisis. In order to analyse and test our hypothesis,
we classified the years 2005-2006 as pre-crisis, 2007-2008 as crisis, and 2009-2011 as post-crisis.

Classifying the times periods into pre-crisis, crisis, and post-crisis helps us better break down the
changes that occurred across the global financial system in the build-up, during and after the crisis.
Data for the reserve requirements was collected from the IMF’s Other Depository Corporation’s Survey,
as a measure of the liquidity funded by central banks we collected the reserve deposits from the survey.
Literature from Keister and McAndrews (2009) suggests that reserve requirements haven’t changed
much over the years in contrast the changes witnessed by the US reserves after the crisis are significant
in nature. Appendix 3 reflects this as we illustrate the levels of reserves in each of the countries in the
sample.

Furthermore, we included a few control variables, to account for the macroeconomic environment we
gather the data on GDP from the World Development Indicators. Secondly, the data on trade openness
is gathered using the Trade (% of GDP) data from the WDI. As we already know based on the literature
that trade openness is simply the sum of exports and imports relative to the GDP.

Regression Model

In order to understand the impact of changes in regulations and policy on international flows, we
estimate a cross-sectional model.

∆Claimsx, y, t = β0 + β1∆Capitalx + β2∆Reservex + Controlsx + Ex, y

Our dependent variable in this case is Changes in International Claims, (∆Claimsx, y, t). ∆Capitalx reflects
the change in a specific country’s capital requirement and ∆Reservex reflects the change in a specific
country’s reserve requirement. The control variables are denoted by the matrix Controlsx, y.

Due to the simple nature of the equation, we can evaluate our first two hypothesis. We test the effects
of changes in capital requirements in country s and country r with use of coefficients β1 and β2.
Parameter β3 and β4 help us measure the impact of changes in reserve requirements on international
claims. The changes in regulation will be help shed light on whether banks are attracted by the less
stringent regulatory markets. For the third hypothesis we use the Overall Capital Stringency Index and
the Reserves held at Central Bank.

Expectations

Hypothesis 1

We are testing whether domestic agents will look for funding from abroad if the capital requirements
in the domestic country are increased. Meaning that higher the capital requirements in the domestic
country, higher the chances of domestic agents to indulge in borrowing from abroad. Hence, we expect
the coefficients on changes in capital requirements, β1, to be negative.

Hypothesis 2

This hypothesis suggests that an increase in reserve requirements will encourage domestic agents to
borrow from foreign banks. Meaning that the higher the reserve requirements of the home country,
the more likely their residents will borrow from abroad. Thus, we expect that the coefficient β2 to be
negative.
Hypothesis 3

Here we are testing whether countries with less stringent regulation attract credit inflows from
countries with stricter regulatory framework. Meaning that countries with a large increase in
regulation is less likely to attract large amount of capital. This means, we expect the coefficient of the
regression we run using the Overall Capital Stringency Index and the Reserves held at Central Bank to
be negative.

Analysis and Regression Results

Table 3 presents the results of our regression sample for the period, pre-crisis.

The control variables performed as expected, there was a positive correlation between the GDP and
the borrowing from abroad. As banks shift credit to markets with higher yields, you more or less expect
this to occur.

We find evidence that an increase in capital requirements will result in an increase in non-bank
borrowing by domestic agents from foreign banks. As seen in Tables 3 & 4, an increase in capital
requirements will motivate domestic agents to start borrowing at a higher rate from abroad. We would
have liked to take this further to investigate the impacts of decreasing capital requirements, however
not many jurisdictions have lowered capital requirements. Also, there is no literature that suggests
decrease in capital requirements would affect the amount of international claims. We do not reject
the null hypothesis.

Reserve requirements showed the output that was predicted earlier, an increase in reserve
requirements will help the growth of rate of borrowing from abroad. Tables 3 & 4 again illustrate the
results of our regression with regards to regulation surrounding the reserves. The results point towards
a positive correlation between the change in reserve deposits and an increase in GDP. Banks prefer
avoiding regulation, they seem to have exploited loopholes in the regulatory framework surrounding
capital stringency across various different jurisdictions.

As we saw in Tables 1 & 2, arbitrage in capital stringency has declined post crisis. This is better
explained by the trend in improving bank regulatory framework post crisis, countries are implementing
the new Basel laws and developing markets especially are taking advantage of this by imposing stricter
but relatively lenient regulation compared to developed markets in order to attract foreign funding.

Finally, our third hypothesis suggested that credit moves from a country to another which has more
lenient regulation. We found that countries with a significant increase in Official Supervisory power,
and/or Overall independence of the Supervisor, and/or Overall capital stringency saw an increase in
their international claims. Meaning credit was flowing out of the country. These finding build on and
align well with that of Houston et al. (2012), Reinhardt and Sowerbutts (2015), and Bremus and
Fratzscher (2014). When considering the economic significance of our results, we understand that an
increase in the change in supervisory power in a developed country will significantly increase the credit
outflow from that country.
Conclusion

After the financial crisis, there has been major debate about using instruments and measures to
identify the extent of systemic risk within the banking sector. The results of our regressions showed
that increased capital requirements encourages domestic non-bank private sector institutions and
individuals to start borrowing from abroad or through foreign affiliates within the country. One big
identification we made is that if the capital requirements are to be executed on an uneven basis or
without fully implementing the contingencies then there will be an increase in borrowing from abroad.

It has been discussed and debated across the literature that exists, that the drivers of international
capital flows are mainly uneven implementation of regulation or imposing stricter legislation. Our
results showed the clear distinguish between developed capital markets and emerging ones. Capital
shifted to many of the emerging market countries in the sample as soon as stricter regulation was
imposed in the developed countries. The new Basel law that is predicted to be implemented this year,
2019 is a tremendous step in generalizing the regulation followed by countries across the globe.

Let’s also not forget what the literature taught us about the impact leakages could have on
international bank flows, it is worth noting that it could actually be beneficial to extend the principle
of reciprocity. The European Systemic Risk Board is analysing data based on cross-border credit flows
to coordinate and execute plan to aid all member states to achieve an optimal reciprocation strategy.

Our results showed that a developed countries experienced a bigger increase in capital stringency and
that they shifted more credit abroad. However, the increase in regulation did not encourage lending
to other developed markets, but rather in emerging markets which have lenient regulatory
requirements comparatively and produce higher yields.

The output from the regression clearly explains the positive correlation between reserve requirements
and international capital flows. In the case of increase reserve requirements there is a small but
significant increase in borrowing from abroad. Vice versa is also true.

Our findings based on capital to asset ratio also shed light on the fact that banks across the world have
reduced their cross-border activities. This makes it hard to conclude on the effects of changes in capital
and reserve requirements, hence we conclude that changes in regulation within the financial sector
differ according to the specific nature of regulation, the region of the developed and emerging market
countries.

It becomes increasingly important in this day and age, to ensure that a transparent and properly
coordinated regulatory framework is in place to monitor closely and intervene when necessary.
Furthermore, I would be interested in analysing the aggregate areas separately to identify other key
drivers of changes in international credit flow.
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Appendix 1

Countries in the Sample:

Developed: Australia, Austria, Canada, France, Germany, Ireland, Italy, Mexico, Netherlands, and USA.

Emerging markets: Belarus, Belgium, Brazil, Bulgaria, Colombia, Denmark, Finland, Ghana, Greece,
Kenya, Moldova, Nigeria, Poland, Portugal, Romania, Russian federation, Slovenia, South Korea, and
Thailand.
 Appendix 2
Variable
International Claims –
Immediate counter party
basis
Arbitrage in Capital
Stringency
Arbitrage in Official
Supervisory Power
Arbitrage in Independence of
Supervisor Computed similarly as the two variables
above.
GDP
Trade Openness/Trade (%
GDP)
Regulatory Quality
Capital to Assets Ratio
Overall Capital Stringency
Overall Independence of
Supervisor
Official Supervisory Power
Reserves at the Central Bank
(% GDP)
Description Source
The data collected is the total International Bank for International
claims on an immediate counter party Settlements (BIS), Consolidated
basis. Banking Statistics
Arbitrage here is computed based on the Barth et al. (2007, 2011 & 2013)
work conducted by Bremus and Fratzscher
(2014), it is measured as the difference
between the regulatory variable in the
developed and the emerging market
country. A higher value indicates that the
source country has stricter regulations
relative to the recipient country.
Same as above, computed as the Barth et al. (2007, 2011 & 2013)
difference between the regulatory variable
in the source and the recipient country.
Barth et al. (2007, 2011 & 2013)
Gross Domestic Product, used as a control World Development Indicators
variable for macroeconomic conditions. (WDI)
Sum of exports and imports as a World Development Indicators
percentage of the GDP (WDI)
Measure for the quality of the regulatory World Bank Governance
framework within a country. Higher the Indicators
value the better the regulatory quality.
Ratio of the total bank capital and reserves World Development Indicators
to total assets (WDI)
Measure of the length to which capital Barth et al. (2007, 2011 & 2013)
requirements reflect risk elements and to
which markets value losses are deducted
before achieving minimum capital
adequacy. Higher the value, the stricter the
regulation.
The extent to which the banking Barth et al. (2007, 2011 & 2013)
supervisory authority in place is not
affected by the government, the banking
industry and political agendas. Higher the
value, higher the independence.
The extent to which supervisory authorities Barth et al. (2007, 2011 & 2013)
are able to intervene and take action to
maintain stability in the financial system.
Higher values mean stronger supervisory
power.
Reserves of commercial banks being held International Financial Statistics
at the central bank divided by the GDP. (IMF)
Appendix 3

Developed Countries

Reserves at Central Bank

1,700,000.00
1,600,000.00
1,500,000.00
1,400,000.00
1,300,000.00
1,200,000.00
1,100,000.00
1,000,000.00
900,000.00
800,000.00
700,000.00
600,000.00
500,000.00
400,000.00
300,000.00
200,000.00
100,000.00
0.00
2005 2006 2007 2008 2009 2010 2011
Australia Austria Canada France Germany
Ireland Italy Mexico Netherlands United States

Emerging Countries

Reserves at Central Bank

3,500,000.00

3,000,000.00

2,500,000.00

2,000,000.00

1,500,000.00

1,000,000.00

500,000.00

0.00
2005 2006 2007 2008 2009 2010 2011
Belarus Belgium Brazil Bulgaria Denmark Finland
Ghana Greece Kenya Moldova Nigeria Poland
Portugal Romania Russia Slovenia Spain Thailand
Appendix 4

Total International Claims

Developed Countries

Total International Claims for the Sample Period(s)

4,500,000.00
4,000,000.00
3,500,000.00
3,000,000.00
2,500,000.00
2,000,000.00
1,500,000.00
1,000,000.00
500,000.00
0.00
1 2 3 4 5 6 7

Australia Austria Canada France Germany

Ireland Italy Mexico Netherlands United States

Emerging Markets

Total International Claims

200,000,000.00
180,000,000.00
160,000,000.00
140,000,000.00
120,000,000.00
100,000,000.00
80,000,000.00
60,000,000.00
40,000,000.00
20,000,000.00
0.00
1 2 3 4 5 6 7

Belarus Belgium Brazil Bulgaria

Colombia Denmark Finland Ghana
Greece Kenya Korea, Rep. Moldova
Nigeria Poland Portugal Romania
Russian Federation Slovenia Spain Thailand
Appendix 5

Overall Capital Stringency

 Overall capital stringency Whether the capital requirement reflects certain risk elements and
deducts certain market value losses from capital before minimum capital adequacy is
determined (Higher values indicate greater stringency)
 Yes = 1; No = 3.1(a) + 3.2(a) + 3.2(b) + 3.18.3(d)* 3 + 1(if 3.18.2 , 0.75).
 3.1 Which regulatory capital adequacy regimes did you use as of end of 2010 and for which
banks does each regime apply to (if using more than one regime)?
 Basel I
 3.2 Which risks are covered by the current regulatory minimum capital requirements in your
jurisdiction?
 Credit risk
 3.18.2 What fraction of revaluation gains is allowed as part of capital?
 3.18.3 Are the following items deducted from regulatory capital? d. Unrealized losses in fair
valued exposures

Official Supervisory Power Index

 Whether the supervisory authorities have the authority to take specific actions to prevent and
correct problems
 For question, 5.10 a = 0; b or c = 1
 For questions, 5.9, 5.12, (b), 12.3.2, 10.5(b), 11.1(f), 11.1(j) and 11.1(k) Yes = 1; No = 0
 For questions, 11.5(a), 11.5(b) and 11.5(c) BS = Bank Supervisor = 1 DIA = Deposit Insurance
Agency = 0.5 BR/AMC, Bank Restructuring or Asset Management Agency = 0.5 C = Court = 0;
and OTH = Other - please specify = 0 5.10 + 5.9 + 5.12(b) + 12.3.2
 10.5(b) + 11.1(f) + 11.1(j) + 11.1(k)* 2 + 11.5(a) + 11.5(b) *2 + 11.5(c)*2
 5.9 Are auditors required to communicate directly to the supervisory agency any presumed
involvement of bank directors or senior managers in illicit activities, fraud, or insider abuse?
 5.10 Does the banking supervisor have the right to meet with the external auditors and discuss
their report without the approval of the bank? a. No b. Yes, it happens on a regular basis c. Yes,
it happens on an exceptional basis
 5.12 In cases where the supervisor identifies that the bank has received an inadequate audit,
does the supervisor have the powers to take actions against [...] b. The external auditor
 10.5 Do banks disclose to the supervisors [...]? b. Off-balance sheet items
 11.1 Please indicate whether the following enforcement powers are available to the
supervisory agency f. Require banks to constitute provisions to cover actual or potential losses
j. Require banks to reduce or suspend dividends to shareholders k. Require banks to reduce or
suspend bonuses and other remuneration to bank directors and managers
 11.5 Which authority has the powers to perform the following problem bank resolution
activities? Enter the initials of the corresponding authority from the following list of options a.
Declare insolvency b. Supersede shareholders’ rights c. Remove and replace bank senior
management and directors
 12.3.2 Can the supervisory authority force a bank to change its internal organizational
structure?
Overall Independence of the Supervisor

 Overall Sum of (VI.II) þ (VI.III) þ (VI.IV) (Higher values indicate greater independence) Sum of
(VI.II) þ (VI.III) þ (VI.IV)
 The three parameters you need are independence of supervisory authority from political
agenda.
 Secondly, the independence of the supervisory authority from the government.
 Finally, the independence of the supervisory authority from the banking sector.
 12.4 To whom is the supervisory agency legally responsible or accountable? c. A legislative
body, such as Parliament or Congress Independence of supervisory authority bank The degree
to which the supervisory authority is protected by the legal system from the banking industry
(Higher values indicate greater independence) Yes = 0; No 1
 12.9 Can individual supervisory staff be held personally liable for damages to a bank caused by
their actions or omissions committed in the good faith exercise of their duties? Independence
of supervisory authority fixed term The degree to which the supervisory authority is able to
make decisions independently of political considerations (Higher values indicate greater
independence) A fixed term of four years or greater = 1; less than four years or no fixed term
=0
 12.6 Does the head of the supervisory agency have a fixed term?
 12.6.1 If yes, how long (in years) is the term?
Table 1: Descriptive summary for the regression sample. Changes in the pre-crisis period.

Mean Std Dev Min Max

Bilateral Variables

International Claims -10.750 6.828 -33.340 16.428

Arbitrage capital stringency 0.100 0.240 0.000 0.000
Arbitrage official supervisory power 10.597 3.104 5.950 13.860
Arbitrage independence of
supervisor -0.150 0.032 0.000 0.000

Developed
GDP 0.076 0.027 0.049 0.125
Trade (%GDP) 0.035 0.043 -0.101 0.095
Capital/Assets (%) 0.018 0.034 -0.014 0.085
Overall Capital Stringency Index 5.200 1.687 1.000 7.000
Official Supervisory Power 10.700 3.129 6.000 14.000
Overall Independence of Supervisor 1.800 0.919 0.000 3.000
Reserve Deposits/GDP 0.000 0.000
Regulatory Quality 0.130 0.003 -0.020 1.000

Developing Markets
GDP 0.199 0.191 0.057 0.902
Trade (%GDP) 0.021 0.095 -0.329 0.288
Capital/Assets (%) 0.011 0.044 -0.051 0.180
Overall Capital Stringency Index 5.100 1.447 1.000 7.000
Official Supervisory Power 0.104 0.025 0.050 0.140
Overall Independence of Supervisor 1.950 0.887 0.000 3.000
Reserve Deposits/GDP 0.000 0.000
Regulatory Quality 0.421 0.021 -1.750 9.000
Table 2: Descriptive summary for the regression sample. Changes in the post-crisis period.

POST CRISIS
Mean Std Dev Min Max
Bilateral Variables

International Claims 0.010 0.150 -0.240 0.565

Arbitrage capital stringency 0.200 0.336 -1.000 0.000
Arbitrage official supervisory power 10.746 1.947 5.950 12.860
Arbitrage independence of supervisor -0.100 0.118 1.000 -3.000

Developed
GDP 0.015 0.110 -0.189 0.235
Trade (%GDP) 0.018 0.104 -0.173 0.148
Capital/Assets (%) 0.069 0.128 -0.106 0.451
Overall Capital Stringency Index 5.500 1.716 2.000 7.000
Official Supervisory Power 10.850 1.973 6.000 13.000
Overall Independence of Supervisor 2.200 0.919 1.000 0.000
Reserve Deposits/GDP 0.000 0.010
Regulatory Quality -0.023 0.001 -0.353 0.136

Developing Markets
GDP 0.036 0.134 -0.264 0.345
Trade (%GDP) 0.021 0.132 -0.256 0.397
Capital/Assets (%) 0.098 0.808 -0.773 6.124
Overall Capital Stringency Index 5.300 1.380 3.000 7.000
Official Supervisory Power 0.105 0.026 0.050 0.140
Overall Independence of Supervisor 2.300 0.801 0.000 3.000
Reserve Deposits/GDP 0.000 0.000
Regulatory Quality -0.021 0.005 -3.000 1.625
Table 3: Determinants of changes in international claims pre-crisis (2005-2006), our dependent
variable is defined by the function ΔIx, y = ln (Lx, y 2006) − ln (Lx, y 2005).

Control
Variable Capital Reserve
(1) (2) (3)

GDP Developed -0.067 -0.06 0.23

GDP Emerging 1.556 1.442 2.16

Trade openness Developed 0.012 0.004 0.002

Trade openness Emerging 0.035 0.028 0.019

Regulatory Quality Developed -0.016 0.367 0.149

Regulatory Quality Emerging 0.243 0.133 0.072

Capital/Assets Ratio Developed - 0.088 0.104

Capital/Assets Ratio Emerging - 0.011 0.008

Official Supervisory Power Developed - -0.025 -

Official Supervisory Power Emerging - 0.0178 -

Overall independence of supervisor Developed - -0.045 -

Overall independence of supervisor Emerging - 0.02 -

Overall Capital Stringency Developed - 0.075 -

Overall Capital Stringency Emerging - 0.026 -

Reserve Deposits Developed - - -1.475

Reserve Deposits Emerging - - -5.586
Table 4: Cognitive influencers on changes in international claims post-crisis (2009-2011). Our
dependent variable in this case is ΔIx, y = ln (Lx, y 2011) – ln (Lx, y 2010).

Control
Variable Capital Reserve
(1) (2) (3)

GDP Developed -0.2491 -0.223 -0.886

GDP Emerging 0.5 0.614 0.593

Trade openness Developed -0.6217 -0.036 -0.025

Trade openness Emerging 0.002 0.002 0.002

Regulatory Quality Developed 0.732 0.24 0.947

Regulatory Quality Emerging -0.466 -0.742 -0.796

Capital/Assets Ratio Developed - 0.589 0.331

Capital/Assets Ratio Emerging - 0 -0.005

Official Supervisory Power Developed - -0.018 -

Official Supervisory Power Emerging - -0.03 -

Overall independence of supervisor Developed - -0.079 -

Overall independence of supervisor Emerging - -0.017 -

Overall Capital Stringency Developed - -0.032 -

Overall Capital Stringency Emerging - 0.063 -

Reserve Deposits Developed - - -0.0149

Reserve Deposits Emerging - - -0.0242