Why Reregulation after the Crisis is Feeble: Shadow Banking, Offshore Financial Centers and Jurisdictional Competition

Abstract

A crucial element in the complex chain of factors that caused the recent financial crisis was the lack of regulation and oversight in the shadow banking sector, which is largely incorporated in offshore financial centers (OFCs). But instead of swift and radical regulatory reform in that sector after the crisis, we observe only incremental and ineffective measures. Why? The paper develops an explanation based on a two-level game. On the international level, governments are engaged in jurisdictional competition for financial activity. On the domestic level, governments are prone to capture by financial interest groups, but also susceptible to demands for stricter regulation by the electorate. Governments try to square the circle between the conflicting demands by adopting incremental and symbolic, but largely ineffective reforms. The explanation is put to empirical scrutiny by tracing the regulatory initiatives on shadow banks and OFCs at the international level and within the USA and the European Union, where I focus on France, Germany and the United Kingdom.