Bank regulation and systemic risk: cross country evidence

Abstract

Using data for banks from 65 countries for the period 2001–2013, we investigate the impact of bank regulation and supervision on individual banks’ systemic risk. Our cross-country empirical findings show that bank activity restriction, initial capital stringency and prompt corrective action are all positively related to systemic risk, measured by Marginal Expected Shortfall. We use the staggered timing of the implementation of Basel II regulation across countries as an exogenous event and use latitude for instrumental variable analysis to alleviate the endogeneity concern. Our results also hold for various robustness tests. We further find that the level of equity banks can alleviate such effect, while bank size is likely to enhance the effect, supporting our conjecture that the impact of bank regulation and supervision on systemic risk is through bank’s capital shortfall. Our results do not argue against bank regulation, but rather focus on the design and implementation of regulation.