Multinational Banks and Financial Stability

Abstract 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 noncooperatively fail to achieve the globally efficient outcome, underregulating domestic banks and overregulating foreign banks. Surprisingly, noncooperative national governments using revenue-generating Pigouvian taxation can achieve the global optimum. Intuitively, this occurs because governments internalize the business value of foreign banks through the tax revenue collected. Our theory provides a unified framework to think about international bank regulations and yields concrete insights with the potential to improve on the current policy stance.