Multinational Banks and Financial Stability

We study the scope for international cooperation in macroprudential policies. Multinational banks contribute to and are affected by fire sales in countries they operate in. National governments setting quantity regulations non-cooperatively fail to achieve the globally efficient outcome, under-regulating domestic banks and over-regulating foreign banks, necessitating international cooperation. Surprisingly, non-cooperative national governments using Pigouvian taxation can achieve the global optimum. Intuitively, this occurs because applying taxes, rather than quantity regulations, leads governments to internalize the business value of foreign banks through the tax revenue collected. Our theory not only provides a unified framework to think about international bank regulations, but also yields concrete insights with the potential to improve on the current policy stance.