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loss-absorbing capital

National bank regulators

Whereas the bank is global in its operations, the regulators that act as resolution authorities are national. This assumption, which captures the regulatory status quo, constitutes the key regulatory friction in our model. Specifically, we assume that national regulators follow national objectives and that their sovereignty, combined with the territoriality principle of bankruptcy, allows them to ring-fence assets in their own jurisdiction. In the context of our model, ring-fencing means that the diversifiable cash flow |$\Delta$| can be shielded from being used for cross-jurisdictional transfers by the authorities in the jurisdiction where this cash flow materializes (i.e., |$\Delta$| can be ring-fenced in the jurisdiction in which it materializes).In we first consider a benchmark case in which the two national regulators jointly maximize global welfare and can credibly commit to a resolution plan ex ante, thereby emulating a supranational regulatory authority. In which contains our main results, we then contrast this benchmark with the more realistic scenario in which regulators cannot credibly commit to a resolution plan and act according to the best interests of their own jurisdiction. This noncommitment case captures the regulatory status quo because, in the absence of an international treaty on bank resolution, sovereignty makes it impossible for regulators to credibly commit to cooperating with other regulators in a G-SIB resolution. Therefore, when push comes to shove, regulators will act in their own national interest, and regulatory incentive constraints become key to successful resolution.12 While in our model national interests are simply assumed, they arise naturally from political economy considerations. In particular, national regulators are likely to be reluctant to share resources with other jurisdictions in resolution, unless doing so improves the resolution outcome in their own jurisdiction