Capital Rules: The Domestic Politics of International Regulatory Harmonization

In the past fifteen years, financial regulators from the developed world have attempted to create international regulatory standards in a variety of financial issue areas. Their negotiations are notable for the stark variation in the preferences of regulators toward international regulatory harmonization. Certain regulators actively resist any attempts at regulatory harmonization, while others are vocal in their advocacy for an international agreement. When will regulators seek to harmonize their rules with their foreign counterparts? I propose a principal-agent framework for analyzing regulator behavior that views international harmonization as a means of satisfying domestic political pressures. The framework predicts that regulators are more likely to seek international regulatory harmonization when confidence in the stability of financial institutions is declining, and when competitive pressures are increasing from foreign firms facing less stringent regulations. I explore the consistency of the framework with two important cases in the history of international financial regulation: the negotiations among bank regulators leading up to the 1988 Basel Accord on bank capital adequacy, and the negotiations among securities regulators over capital adequacy for securities firms between 1988 and 1992.I thank Gabe Aguilera, David Bach, Ethan Bueno de Mesquita, Dan Carpenter, Bill Clark, Mark Copelovitch, Jeff Frieden, Dan Gingerich, Dan Ho, Devesh Kapur, Joseph N. R. Sanberg, Ross Schaap, Allan Stam, Matt Stephenson, two anonymous reviewers, and the editors of IO for helpful comments, discussions, and feedback. I am also indebted to the thirty current and former regulators and financial industry executives who participated in interviews to advance this project. Finally, I thank the Weatherhead Center for International Affairs and the Center for European Studies for research funding.