Regulatory competition in capital standards with selection effects among banks

Several countries have recently introduced national capital
standards exceeding the internationally coordinated Basel III
rules, thus suggesting a `race to the top' in capital standards. We
study regulatory competition when banks are heterogeneous and give
loans to firms that produce output in an integrated market. In this
setting capital requirements change the pool quality of banks in
each country and inflict negative externalities on neighboring
jurisdictions by shifting risks to foreign taxpayers and by
reducing total credit supply and output. Non-cooperatively set
capital standards are higher than coordinated ones when governments
care equally about bank profits, taxpayers, and consumers.