Regulatory Arbitrage
Regulatory arbitrage occurs when institutions exploit differences in regulations to reduce compliance costs or capital requirements.
Meaning in Practice
Financial institutions may shift activities to jurisdictions with lighter regulations or structure transactions to minimize regulatory burdens. This can include moving assets off balance sheet or using complex financial instruments.
Why It Matters
Regulatory arbitrage can undermine the effectiveness of financial supervision and increase systemic risk. It creates uneven competition and weakens global regulatory consistency.
Market Impact
Short-term profitability may improve when firms reduce regulatory costs. However, excessive arbitrage can increase hidden risks and trigger market instability during stress.
Example
A bank relocates certain trading operations to a country with lower capital requirements to reduce regulatory costs.