Foreign Investment, Regulatory Arbitrage, and the Risk of U.S. Banking Organizations

W. Scott Frame, Atanas Mihov, and Leandro Sanz

Working Paper 2017-2
March 2017

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This study investigates the implications of cross-country differences in banking regulation and supervision for the international subsidiary locations and risk of U.S. bank holding companies (BHCs). We find that U.S. BHCs are more likely to operate subsidiaries in countries with weaker regulation and supervision and that such location decisions are associated with elevated BHC risk and higher contribution to systemic risk. The quality of BHCs’ internal controls and risk management play an important role in these location choices and risk outcomes. Overall, our study suggests that U.S. banking organizations engage in cross-country regulatory arbitrage with potentially adverse consequences.

JEL classification: G15, G21, G28

Key words: regulation, supervision, bank holding companies, cross-border operations, subsidiary locations, risk, systemic risk


The authors thank David Becher, Thorsten Beck, Allen Berger, Mitchell Berlin (discussant), Mark Carey (discussant), Eugeneio Cerutti, Stijn Claessens, Ricardo Correa, Ibrahim Ergen, Jean-Pierre Fenech (discussant), Jeffrey Gerlach, Linda Goldberg, Neeltje van Horen (discussant), Andrew Karolyi, Nada Mora, Ned Prescott, John Sedunov, Marti Subrahmanyam, Judit Temesvary, Barry Williams, and seminar and conference participants at the Reserve Bank of Australia, the 2016 International Conference on Financial Cycles, Systemic Risk, Interconnectedness, and Policy Options for Resilience, the 2016 Federal Deposit Insurance Corporation/Journal of Financial Services Research 16th Annual Bank Research Conference, the 2016 Conference on Financial Intermediation in Emerging Markets, and the 2017 Allied Social Sciences Association annual meeting for valuable comments and suggestions. They also thank Tobias Adrian and Markus Brunnermeier for providing bank holding company risk data, and Andrew Ellul and Vijay Yerramilli for providing bank holding company risk management quality data. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta, the Federal Reserve Bank of Richmond or the Federal Reserve System. Any remaining errors are the authors’ responsibility.
Please address questions regarding content to W. Scott Frame, Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, 404-498-8783, scott.frame@atl.frb.org.
Please address questions regarding content to W. Scott Frame, Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, 404-498-8783, scott.frame@atl.frb.org; Atanas Mihov, Federal Reserve Bank of Richmond, 530 East Trade Street, Charlotte, NC 28202, atanas.mihov@rich.frb.org; or Leandro Sanz, Federal Reserve Bank of Richmond, 530 East Trade Street, Charlotte, NC 28202, leandro.sanz@rich.frb.org.
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