The Death of a Regulator: Strict Supervision, Bank Lending and Business Activity

The Death of a Regulator: Strict Supervision, Bank Lending and Business Activity

Joao Granja, Christian Leuz

Series number :

Serial Number: 
447/2019

Date posted :

April 15 2019

Last revised :

July 30 2020
SSRN Share

Keywords

  • bank regulation • 
  • enforcement • 
  • Loan Losses • 
  • Aggregate outcomes • 
  • Prudential oversight • 
  • Business lending • 
  • Entry and exit

An important question in banking is how strict supervision affects bank lending and in turn local business activity. Supervisors forcing banks to recognize losses could choke off lending and amplify local economic woes. But stricter supervision could also change how banks assess and manage loans. Estimating such effects is challenging.

We exploit the extinction of the thrift regulator (OTS) to analyze economic links between strict supervision, bank lending and business activity. We first show that the OTS replacement indeed resulted in stricter supervision of former OTS banks. Next, we analyze the ensuing lending effects. We show that former OTS banks increase small business lending by roughly 10 percent. This increase is concentrated in well-capitalized banks, those more affected by the new regime, and cannot be fully explained by a reallocation from mortgage to small business lending after the crisis. These findings suggest that stricter supervision operates not only through capital but can also correct deficiencies in bank management and lending practices, leading to more lending and a reallocation of loans

Authors

Real name:
Joao Granja