Our research starts with the recognition that the scope and depth of Basel II and III adoption in LMICs is not merely determined by technocratic assessments of suitability and fit. Instead, regulators’ decisions are influenced by the political economy of interrelations among key domestic actors, their respective incentives, and the international context they operate in.
Our argument focuses on three sets of actors: regulators, politicians, and banks. We start by setting out the political and institutional conditions under which we expect each of these actors to support or oppose the implementation of international banking standards. In general, an international orientation provides incentives to implement international standards, while a domestic orientation tends to dissuade actors from implementation.
Contrary to commonly held assumptions, we do not find much empirical support that the IMF and the World Bank push LMICs towards the adoption of Basel II and III. The institutions have even spoken out against a hasty adoption of these standards in many countries, with the important exception of WAEMU. Another counter-intuitive finding of our research is that global banks do not seem to play a key role in advocating Basel standards adoption in LMICs. Both sets of actors however are relevant in influencing the domestic political economy of Basel adoption.
Regulators: We differentiate between internationally oriented and domestically oriented regulatory authorities. The former are extensively linked into international peer networks, while the latter are relatively detached from international regulatory debates and much less likely to be influenced by them. We expect the training and career trajectories of leading officials to be important in determining how internationally oriented the regulatory authority is. The international orientation of regulators is necessary, but it is not sufficient for a country to adopt and implement Basel II and III.
Politicians: We expect incumbent politicians to favour the implementation of Basel II/III and other global financial standards when they are internationally oriented, for example in pursuing a development strategy of attracting foreign investors and establishing the country as a financial hub. Conversely, domestically oriented politicians that endorse a more interventionist approach to development are expected to pay little attention or even oppose Basel standards implementation.
Banks: Despite the cost of implementing Basel II/III, internationally oriented banks may have an incentive to advocate for these standards. For example, domestic banks may want to obtain the imprimatur of a global quality standard and its reputational benefits as they seek to attract foreign investors or expand abroad. Larger and/or global banks may also regard Basel as a means to gain competitive advantage over smaller rivals. Conversely, domestically oriented banks (of both foreign and local origin) are expected to be indifferent or opposed to Basel implementation.
Quantitative research provides empirical support for the drivers of Basel adoption identified in this framework. Non-Basel member jurisdictions with domestic banks operating abroad are likely to adopt more of Basel II, as Jones & Zeitz (2017) show. In another paper, Jones & Zeitz (in progress) use spatial lags regressions to identify cross-border banks, supervisory networks, and competition on global capital markets as drivers for Basel II adoption. In other words, regulators are likely to adopt more of Basel II (1) the more foreign banks operate in their jurisdiction, (2) the more domestic banks have operations abroad, (3) the more of their peers in supervisory networks have adopted Basel II, and (4) the more jurisdictions with the same sovereign credit rating have adopted Basel II. Even though these results are based on the full range of non-Basel Committee members at all income levels, we find evidence for most of these channels of diffusion in LMICs in particular.
These are the building blocks of the analytical framework. Guided by this framework our team of researchers has engaged in in-depth analysis of the political economy of Basel standards adoption in 11 countries on 3 continents. From the wealth of empirical material gathered in this project we can distill the following 6 ideal types that exhibit a stylised relationship between the orientations of domestic actors and the depth and scope of Basel standards adoption:
Type 1: Domestic Consensus
Regulators, politicians, and market participants share a predominantly domestic orientation. Regulators have limited international experience or involvement in transnational networks, politicians pursue a development strategy based on financial interventionism, and the banking sector has few outside connections. As a result, no Basel II/III adoption is pursued.
Type 2: Regulator-driven Adoption
In the third ideal type of our framework the financial regulator champions Basel adoption. Leading officials in the regulatory agency may be involved in professional peer networks or count on a career background in international financial institutions. Politicians and market players however are domestically oriented. This constellation of interests may lead to a considerable implementation gap between formal Basel adoption and the scope of Basel rules that are in force.
Type 3: Politically Driven Adoption
Politically driven Basel adoption can be expected in jurisdictions where incumbent politicians seek to raise the salience of the domestic financial system on the global market. But the political impetus to use global financial standards implementation to attract foreign investors is attenuated by capacity constraints among regulators and divergent incentives among key players in the banking system, leading to slow Basel adoption.
Type 4: Market-driven Adoption
Market-driven adoption occurs when banks are banks are champions of Basel standards. Domestic banks that seek to expand abroad or maintain international banking relationships are typical Basel supporters, but international banks can also play that role. Their interests however are not aligned with domestically oriented politicians and constrained regulators, leading to delays in Basel adoption.
Example: none among our sample of cases
Type 5: International Consensus
Incumbent politicians, regulators, and market players all support Basel adoption, albeit for different reasons. Politicians may be driven by concerns over international investors, whereas regulators regard Basel II/III as the golden standard for financial stability, and banks seek to derive competitive advantage and international recognition from Basel adoption. This alignment of interests is associated with wide and deep Basel adoption.
Type 6: Conflicting Preferences
Key domestic actors have conflicting preferences regarding banking regulation. Politicians may seek the reputational benefits of global standards, but are hesitant to implement them because greater scrutiny would expose political lending practices. Similarly, banks and regulators regard Basel II/III as internationally beneficial, but may fear bankruptcy and ensuing financial instability if veritable standards implementation were to succeed. Such conflicting preferences are associated with mock compliance, where superficial Basel adoption is combined with substantial non-compliance.
It is important to note that no jurisdiction in our sample of cases neatly fits one ideal type. The case studies in our project exceed the ideal types in detail and complexity. Summaries of all 11 case studies are available here.