Inconsistent Regulators: Evidence from Banking

59 Pages Posted: 3 Jan 2012 Last revised: 10 Apr 2013

Sumit Agarwal

Georgetown University - Department of Finance

David O. Lucca

Federal Reserve Banks - Federal Reserve Bank of New York

Amit Seru

Stanford University

Francesco Trebbi

Vancouver School of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: April 1, 2013

Abstract

We find that regulators can implement identical rules inconsistently due to differences in their institutional design and incentives and this behavior adversely impacts the effectiveness with which regulation is implemented. We study supervisory decisions of U.S. banking regulators and exploit a legally determined rotation policy that assigns federal and state supervisors to the same bank at exogenously fixed time intervals. Comparing federal and state regulator supervisory ratings within the same bank, we find that federal regulators are systematically tougher, downgrading supervisory ratings almost twice as frequently as state supervisors. State regulators counteract these downgrades to some degree by upgrading more frequently. Under federal regulators, banks report higher fraction of nonperforming loans, more delinquent loans, higher regulatory capital ratios, and lower returns on assets. Leniency of state regulators relative to their federal counterparts is related to costly consequences and likely proxies for delayed corrective actions—more lenient states have higher bank-failure rates, lower repayment rates of government assistance funds, and more costly bank resolutions. Moreover, relative leniency of state regulators at the bank level predicts the bank's subsequent likelihood of severe distress. The discrepancy in regulator behavior arises because of differences in how much regulators care about the local economy as well as differences in human and financial resources involved in implementing the regulation. There is no support for the corruption hypothesis, which includes “revolving doors” as a reason for leniency of state regulators. We conclude by discussing broader applicability of our findings as well as implications of our work for the design of banking regulators in the U.S. and Europe.

Keywords: Banking Regulation, Banking Supervision, Dual Banking, CAMELS, Financial Institutions, European Banking

JEL Classification: G21, G28

Suggested Citation

Agarwal, Sumit and Lucca, David O. and Seru, Amit and Trebbi, Francesco, Inconsistent Regulators: Evidence from Banking (April 1, 2013). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1978548 or http://dx.doi.org/10.2139/ssrn.1978548

Sumit Agarwal (Contact Author)

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States
202-687-8207 (Phone)

HOME PAGE: http://www.ushakrisna.com

David O. Lucca

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Amit Seru

Stanford University ( email )

650 Knight Management
Stanford, CA 94305
United States

Francesco Trebbi

Vancouver School of Economics ( email )

University of British Columbia
6000 Iona Dr.
Vancouver Canada, BC V6T 1L4
Canada

HOME PAGE: http://faculty.arts.ubc.ca/ftrebbi/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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