The Politics and Economics of Overcompliance #VirtualAPSA2012

William Kindred Wineco

William Kindred Wineco The Politics and Economics of Overcompliance #VirtualAPSA2012

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University of North Carolina at Chapel Hill

September 1, 2012

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The Problem

It wasnt only economists that got embarrassed by the nancial crisis.

Cohen: IPE embarrassing and myopic. Mosley & Singer: The discipline doesnt study nancial markets and actors. Helleiner & Pagliari: Existing theories of regulations are insucient.

This is part of my broader research project trying to address these concerns.

William Kindred Wineco The Politics and Economics of Overcompliance #VirtualAPSA2012

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The Question

What motivates the behavior of nancial rms?

Prior theory (mostly taken from econ) universally expects race to the bottom behavior.

One focuses on getting to the Pareto frontier; the other focuses on where along the frontier we end up.
Sounds reasonable, but theres one problem:

William Kindred Wineco The Politics and Economics of Overcompliance #VirtualAPSA2012

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Functionalists: regulation can be welfare-enhancing. Public Choice: regulation generates market failures via rent capture.

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A Snapshot of Firms Risk, OECD

William Kindred Wineco The Politics and Economics of Overcompliance #VirtualAPSA2012

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OECD Tier 1 Mean OECD Tier 1 + 2 Mean Basel Tier 1 Minimum Basel Tier 1 + 2 Minimum 5 10 15 20 1990 1995 Year 2000 2005

Capital Adequacy Ratios (OECD Averages)

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The Descriptive Empirics

Similar patterns in other regions.

Lots of variation at the rm level.

Variation within across countries and time.

Essentially no literature explaining this. (Bernauer & Koubi 2006 as the exception.)

William Kindred Wineco The Politics and Economics of Overcompliance #VirtualAPSA2012

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The Puzzle

Why would rms over-comply to this extent?

What political and economic forces drive the variation? Why isnt there a race to the bottom?

William Kindred Wineco The Politics and Economics of Overcompliance #VirtualAPSA2012

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The Argument

Finance is dierent from other industries: both supply-side and demand-side forces inuence prots.
1

Banks prot by exploiting dierence between interest paid (for deposits) and interest earned (on loans). 2 I.e., banks need to attract funds before they can invest them. Thus have a need to signal prudence. 3 This signal is aected by rm-level characteristics in addition to the macro political economy.
There is a demand-side incentive to race to the bottom; there is also a supply-side incentive to climb to the top. Banks can prot either way. So which do they choose?

William Kindred Wineco The Politics and Economics of Overcompliance #VirtualAPSA2012

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The Hypotheses

Dierent types of institutions, operating in dierent types of environments, make dierent choices:

Firms with riskier proles (e.g. investment banks) and publicly listed rms have greater need to signal prudence. Large rms have lesser. Firms in countries with regulatory central banks and high monetary independence will have less capital. (Perhaps monetary moral hazard?) Firms in countries with super-equivalent local standards will have higher. Firms in poor countries cant signal eectively, in rich countries (e.g.) have less need. Firms in countries with higher savings rates will face less pressure for prudence; where there is lots of competition will face more.
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The Data and Method

Data:

Bank-level data from BankScope. National-level economic data from World Bank. National-level regulation data from World Bank surveys (2000, 2003, 2006).
Method:

Bayesian regression (diuse normal priors, 50k burn-in, 500k post burn-in, xed eects for countries and years).

William Kindred Wineco The Politics and Economics of Overcompliance #VirtualAPSA2012

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The Results

Generally as expected: variables at all levels matter:

Positive eect: listed institution, investment banks and bank-holding corp, GDP growth, high income non-OECD, ination, countrys assets, super-equivalent regulation. Negative eect: Firm assets, monetary independence, regulatory central bank, poor and OECD countries, domestic savings rate. Less substantively signicant eect: capital account openness, exchange rate stability.

William Kindred Wineco The Politics and Economics of Overcompliance #VirtualAPSA2012

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