Does Regulatory Bank Oversight Impact Economic Activity? A Local Projections Approach

37 Pages Posted: 7 Mar 2016 Last revised: 8 Mar 2016

See all articles by Vivian Hwa

Vivian Hwa

FDIC, Division of Insurance and Research

Pavel S. Kapinos

Federal Reserve Bank of Dallas--Financial Industry Studies

Carlos D. Ramirez

George Mason University - Department of Economics

Date Written: January 19, 2016

Abstract

Existing research generally finds that the magnitude of the effect of supervisory rating shocks on real economic activity is small and short-lived. This is puzzling because corrective actions addressing weaknesses in underwriting and other practices frequently include lending restrictions and thus would be expected to have a stronger effect on real activity. As supervisory actions curb poorly underwritten or uneconomic loans, transmission of macroprudential policy throughout the macroeconomy should be evident in the dynamic responses of the real GDP and other measures of real activity. We use the local projections approach to estimate impulse responses from a vector autoregression (VAR) model. We show that the effect of supervisory stringency shocks is larger than the one estimated with the standard Cholesky structural VAR approach. We find that the effects are asymmetric: bank downgrades lead to a pronounced decline in real activity, while upgrades do not result in its increase. This would follow if the decrease is driven by poor lending practices that would not be expected to resume when the bank is upgraded. The linear framework averages out these effects, overstating the impact of upgrades, and understating that of downgrades. Furthermore, we document the presence of nonlinear effects for the downgrade shocks, as their impact increases disproportionately with its size. Such effects are not observed for upgrade shocks. Finally, we demonstrate that our results are robust to the inclusion of a variety of controls and additional endogenous variables.

Keywords: CAMELS ratings; vector autoregression; local projections; asymmetries; macroprudential policy; real activity

JEL Classification: G21; E32; E37

Suggested Citation

Hwa, Vivian and Kapinos, Pavel S. and Ramirez, Carlos D., Does Regulatory Bank Oversight Impact Economic Activity? A Local Projections Approach (January 19, 2016). FDIC Center for Financial Research Paper No. 2016-02, Available at SSRN: https://ssrn.com/abstract=2743212 or http://dx.doi.org/10.2139/ssrn.2743212

Vivian Hwa (Contact Author)

FDIC, Division of Insurance and Research ( email )

550 17th Street NW
Washington, DC 20429
United States

Pavel S. Kapinos

Federal Reserve Bank of Dallas--Financial Industry Studies ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States

HOME PAGE: http://https://sites.google.com/site/pavelkapinos/

Carlos D. Ramirez

George Mason University - Department of Economics ( email )

4400 University Drive
Enterprise Hall MSN 3G4
Fairfax, VA 22030
United States
703-993-1130 (Phone)
703-993-1133 (Fax)

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