Bargaining in Basel: The Politics of Global Financial Regulation

Abstract

Explaining states’ ability to cooperate in a world defined by anarchy is one of the core puzzles of international relations. Since 1974, the Basel Committee on Banking Supervision has issued regulations governing global banking. Despite often acrimonious negotiations, the committee has produced three major agreements on capital adequacy standards. This thesis seeks to determine when and why international harmonization of banking regulation occurs. I ask two questions: First, when do national regulators support international harmonization? Second, how are regulators’ preferences translated into international agreements? I argue that states are most likely to support international harmonization when bank stability and competitiveness are declining. Regulators face a difficult dilemma – regulations that strengthen the financial system also reduce banks’ competitiveness. Building on the work of David Andrew Singer, I argue that the regulator must choose policies that satisfy the legislature’s minimum thresholds for these two variables. Declining stability and competitiveness shrink the regulator’s win set. Therefore, regulators are forced to seek international harmonization in order to achieve their domestic political ends. At the bargaining table, power determines the ultimate shape of the agreement. Power in Basel Committee negotiations is a function of asymmetric interdependence. By threatening to exclude weaker states from their financial markets, the powerful are able to get their way. I use a process-tracing methodology to test this theory against all three Basel Accords. While Basel I has received significant attention in the scholarly literature, Basel II and Basel III are comparatively under-researched. In the late 1980s, US and UK banks were increasingly unstable. Moreover, lightly regulated Japanese banks were quickly gaining market share. In response, the United States and the United Kingdom supported Basel I, simultaneously increasing stability and leveling the playing field. By the mid- 1990s, stability and competitiveness were on the rise in both the United States and Europe. Therefore, Basel II weakened capital requirements. Basel III negotiations are reminiscent of Basel I. In the aftermath of the 2007–2008 financial crisis, the United States supported stricter regulations but feared the competitive consequences. Over the objections of France and Germany, the United States pushed through stronger international rules. This theory of international regulation explains how cooperation occurs, but it also points to the limitations of the resulting agreements.