Formal Enforcement Actions and Bank Behavior

Abstract

Employing a unique data set for the period 2000-2010, this paper examines the impact of formal enforcement actions targeting the core of the banks' financial safety and soundness in terms of bank capital, risk, and performance. We find that, on average, these actions reduce both the risk-weighted assets and the non-performing loans ratios of punished banks, but there is no increase in the level of regulatory capital. These effects are less powerful during the post-crisis period, suggesting that banks' scope to improve their safety and soundness condition in crisis periods is much more limited. We also find, albeit with some limitations, that the timing of formal enforcement actions is important: the more the actions are deferred relative to the continuous deterioration of the banks' financial condition, the more limited their impact on the risk-based capital ratio, while actions taken earlier help banks to improve their financial soundness.JEL Classification: G01; G21; G28

Bank Market Power and Firm Performance*

“…We use only those formal enforcement actions that are related to violations of rules of the internal control and audit systems of banks, as well the management of information (Delis, Staikouras, and Tsoumas, 2015). We expect that this class of enforcement actions is positively correlated with bank market power.…”

The spillover effect of enforcement actions on bank risk-taking

“…Therefore, we posit that such actions will have the most bearing on banks' financial safety and soundness. Specifically, we expect that these enforcement actions influence bank behavior by minimizing incentives to undertake excessive credit risk activities through at least three basic channels (Delis et al, 2017). First, a formal enforcement action signals adverse information (i.e., the supervisor holds private information on a targeted bank's condition), and this is likely to enhance market discipline and so reduce a bank's risk appetite.…”

“…As such, the few papers available on the subject (Delis et al, 2017;Delis and Staikouras, 2011;Danisewicz et al, 2017) focus on supervisory enforcement actions (i.e., publicly disclosed actions) in empirically investigating the effectiveness of supervision. Delis et al (2017) examine the impact of formal enforcement actions on the safety and soundness of sanctioned banks in terms of bank capital, risk, and performance. Delis and Staikouras (2011) analyze the role of bank supervision in controlling bank risk among sanctioned banks, finding that the relationship between sanctions and risk is linear and negative.…”

“…A central issue linked to spillover effects on unsanctioned banks, in fact, concerns the publication of sanctions on the Supervisory Authority website. In the U.S., enforcement actions for violations of laws, rules or regulations are published on the Office of the Comptroller of the Currency website in useful Excel files; thus, some papers have focused on the U.S. banking system (Delis et al, 2017). Unfortunately, the situation in the European banking system is more variegated: only a few National Central Banks (NCBs) publish enforcement actions (see Delis and Staikouras, 2011), while most prefer that supervisory measures remain confidential.…”

“…The authors assumed that these "less severe actions" would likely not be affected by the local economy (the dependent variable) and thus would not impact a bank's behavior. Delis et al (2017) used the opening of a new branch in a bank's business as an instrumental variable, stating that it increases the probability of breaching the "law-on-the-books," due to changes in its operational structure.…”