The Effect of Bank Supervision on Risk Taking: Evidence from a Natural Experiment

Abstract

In this paper, we exploit a natural experiment in which thrifts in several states witnessed an exogenous reduction in supervisory attention to assess the effect of supervision on financial institutions' willingness to take risk. We show that the affected institutions took on much more risk than their unaffected counterparts in other districts that were subject to identical regulations. Subsequent to the emergency enlistment of examiners and supervisors from other parts of the country two years later, additional risk taking by the affected thrifts ceased. We find that the expansion in risk taking resulted in a higher incidence of failure as well as more costly failures. None of these patterns are present in commercial banks subject to a different primary supervisory agent but otherwise similar to the thrifts in our sample.JEL classification: G01, G21, G28

The Disciplining Effect of Supervisory Scrutiny in the EU-wide Stress Test

“…For example, Buch and DeLong (2008) show that banks shift risks away from countries with strong supervision. Kandrac and Schlusche (2019) exploit an exogenous reduction in bank supervision, measured by the presence of supervisors' oces, to prove a causal eect of supervisory resources on nancial institutions' willingness to take risk.…”

“…Several studies document a disciplining eect of more intense supervision. They measure the intensity of supervision by the mere presence of supervisors' oces (Gopalan, Kalda, and Manela, 2017;Kandrac and Schlusche, 2019) or their hours worked at a supervised banks (Eisenbach, Lucca, and Townsend, 2016;Hirtle et al, 2019).…”

Banking Supervision, Monetary Policy and Risk-Taking: Big Data Evidence from 15 Credit Registers

“…Specifically, various studies conclude that stricter regulatory oversight can lead to an expansion in lending (Granja and Leuz, 2017) and a reallocation of loans away from firms with negative equity (Bonfim et al 2019). In general, a reduction in supervisory attention leads to an increase in banks' willingness to take risk (Kandrac and Schlusche, 2019). Focusing on heterogeneity across banks, some studies find that because large banks receive more attention from supervisors they tend to hold less risky loans and are less sensitive to industry-specific fluctuations (Hirtle, Kovner and Plosser, 2018;and Eisenbach, Lucca and Townsend 2016).…”

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

“…More broadly, we contribute to a large literature that analyzes the impact of bank regulators on lending (e.g. Eisenbach, Lucca, and Townsend, 2017;Hirtle et al, 2018;Kandrac and Schlusche, 2018;Altavilla, Boucinha, Peydró, and Smets, 2020) and their role in facilitating regulatory forbearance (Kroszner and Strahan, 1996;Brown and Dinç, 2005;Brown and Dinç, 2011;Costello, Granja, and Weber, 2016;Lucca, Seru, and Trebbi, 2014;Bonfim, Cerqueiro, Degryse, and Ongena, 2016). Our work is also related to papers that examine how evergreening affects the allocation of capital in an economy (e.g.…”