In the Shadow of Basel: How Competitive Politics Bred the Crisis

What if global governance mechanisms undermine the capacity of national banking regulators to deal with the deviant activities of their banks? Such was the case, this paper argues with respect to the Basel Accords and the regulation of the bank-based shadow-banking system. Securitization-activities by banks, driven by regulatory arbitrage have been an integral part of the shadow banking sector and a central transmission mechanism during the financial crisis. They have been identified as problematic by the international regulatory community since 1999, motivating reforms in Basel 2. This paper investigates why, nevertheless, regulatory loopholes that allowed banks to engage in these activities without core capital charges persisted in almost all Western jurisdictions pre-crisis. It lays emphasis on the global nature of the securitization business in conjunction with its national regulation, and shows that these national regulations on the fringes of global banking regulation were driven by competitiveness concerns. The Basel Accords were central in this dynamic, as they guaranteed the global nature of this market and gave national banking regulators the leeway to exempt securitization-activities from global regulation. Rather than eliminating competitive inequity concerns, the Basel Accords channelled them to its fringes, where they introduced a regulatory race to the bottom.