The Effects of Regulatory Office Closures on Bank Behavior

Using closures of U.S. bank regulatory offices between 2002 and 2013 as difference-in-differences shocks to the physical proximity between supervisors and the community banks they oversee, the paper asks whether a decentralized network of local supervisory offices produces safer banks. The authors first show closures are not predicted by the risk or performance of the supervised banks — offices near a regional main office with falling workload are the ones shut — which supports treating closures as plausibly exogenous to affected banks. Following a closure, banks previously supervised by the closed office increase total lending by about 6-10% and tilt toward riskier loans (e.g., commercial real estate), and overall risk-taking as measured by the Z-Score rises by roughly 19-32% of the sample mean, with larger increases in distance to the new office associated with riskier policies. Banks affected before the 2008-09 financial crisis subsequently exhibited more bad loans, higher charge-offs, and higher failure rates during the crisis. Examining channels, the authors find affected banks report lower and less timely loan-loss provisions (and more income-increasing provisions, making balance sheets more opaque), increase dividend payouts, and see lower risk-adjusted returns on assets — which they read as evidence that proximity lets supervisors enforce timelier provisioning, restrain payouts, and share expertise. On balance the authors interpret the results as implying that geographical proximity reduces informational frictions in supervisory monitoring and leads to more stable banks — that is, the monitoring-benefit view dominates the regulatory-capture view on average.

Seth Armitage | Macro Paper Warehouse

The Effects of Regulatory Office Closures on Bank Behavior