Theoretical Framework
3.2 The Model and Equilibrium
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立 政 治 大 學
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l C h engchi U ni ve rs it y
3.2 The Model and Equilibrium
After specifying international and domestic political pressures, I assume that a rational government will try to minimize the aggregate political pressures for greater chance of political survival. The aggregate pressure equals the sum of PIand PD.
4 2
Since both a1 and a2 are positive integers, equation (4) is a convex parabola, which allows a minimum value. I take the first derivative of equation (4) and minimize the total political pressure (P) with respect to the level of bank regulation (x), where
5 2 2 0
To find the minimum of P,
6
is the optimal level of bank regulation for the executive body, which is the equilibrium that any rational government will not deviate. Given the level of Basel Accord (b), equation (6) indicates that the equilibrium of bank regulation is decided by an executive branch’s sensitivity to both international (a1) and domestic pressures (a2). Such feature allows us to analyze the variation of national bank regulations resulting from different scenarios.
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國立 政 治 大 學
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Scenario I: The country is not sensitive to international pressure
When only a1 approaches zero, it represents a scenario that the country is not sensitive to international pressure at all but it is sensitive to pressures from domestic politics. In such situation, from equation (6), a1b will approaches zero.
7 lim
→ 0
This means that the national bank regulation will be likely to move to a laissez-faire situation and be very far away from the Basel Accord, which favors the banking sector’s interests. In order words, since international pressure matters nothing, the country only respond to the interests of banking sector as much as it can. Such outcome occurs in economically powerful and non-global rule setting countries or countries that the global society does not even concern at all but have to respond their domestic politics that features strong political lobby or cronyism problems. Figure 3.1(A) illustrates such circumstances. Therefore, I hypothesize that, regardless of domestic pressures confronted, if a country is non-BCBS member and is economically powerful, or the country is not economically dependent on global markets, the level of its national bank regulation, or the compliance with the Basel Accord, will be low.
Scenario II: The country is not sensitive to domestic pressure
When only a2 approaches zero, it represents a scenario that the executive body can shield itself from domestic political pressure but it is sensitive to international pressures.
In such situation, from equation (6), a1 + a2 will approaches a1.
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8 lim
→
This means that the national bank regulation will be likely to comply fully with the Basel Accord, which favors international society’s interests. In order words, since domestic pressure matters nothing, the country only respond to foreign pressures. Such outcome occurs in economically weak country but it has less concern of domestic political factors. This can be shown in figure 3.1(B), which represents the situation of an economically weak country that is ruled by a strong and unchecked executive body.
Therefore, I hypothesize that if a country is economically weak while has greater discretion on the level of bank regulation, it is likely to fully comply with Basel Accord.
Figure 3.1 Country only sensitive to either international or domestic pressures
Scenario III: The country is not sensitive to both pressures
In this scenario, both a1and a2 approach zero. From equation (6),
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9 lim
, → , →
It seems unclear to interpret this result by the equilibrium of the formula, but figure 3.2 gives us a clearer view. In this situation, we can see that both kinds of pressures are approaching zero regardless of the level of bank regulation. The sum of both pressures, though different given different x, is similar in any levels of regulation and approaching zero. It indicates that in this ideal type, country can choose whatever bank regulation it likes without suffering from political pressures. Such type of country is more likely to have greater discretion power on bank regulation whatever level it prefers. This can represent a situation for a very powerful, isolated, and centralized autocratic regime.
Figure 3.2 Country insensitive to both international and domestic pressures
Yet it does not mean that this type of country can freely change its bank regulations.
One should contrast this empirical situation with other types of countries that will be subject to higher political pressure sensitivity and pressure itself. Therefore I hypothesize that a country that is economically strong and unchecked by other domestic
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parties, it is likely to be left more leeway to decide its own desired level of bank regulation.
Scenario IV: The country is sensitive to both pressures
In the situation that a country is sensitive to both pressure, then from equation (6), the minimum aggregate political pressures equals
10
For simplicity, I assume that a1 equals a2, which represents that the degree of sensitivity to both pressures are similar, then the new equilibrium will be in the middle between a laissez-faire situation and a fully compliance of Basel Accord.
11
2 2
This happens when international and domestic pressures are the same because b/2 resides on the x where both pressure functions intersect with each, which is the solution of equations (2) and (3). This result yields an important implication: when a country is equally sensitive to both international and domestic political pressures, its optimal level of bank regulation will be the one that balance the pressure from both international and domestic sources, which minimizes that aggregate pressure. Therefore I hypothesize that if a country is weak and can be easily checked by domestic political force, the equilibrium level of bank regulation is likely to create equal international and domestic political pressures that minimize the aggregate pressures.
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國立 政 治 大 學
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Figure 3.3 Country sensitive to both international and domestic pressures
If we use equation (11) as a refrence point, and analyze together with equations (7) amd (8), we can get a more comprehesive underataning of the effect of both pressures.
When the government’s level of sensitivities to both pressures are similar, it will be checked by both pressures and reaches compromised bank regulations. But if the domestic pressure sensitiviely level increases relative to the international pressure, the bank regulation result will move backward from the former compromised points, as a reponse to the domestic lobbying forces. On the contrary, if the international pressure rises relative to the domestic pressure, the new equilbrium will move closer the ideal point of the Basel Accord, as a positive reply to international factors.