Bank Capital and Loan Monitoring
The Accounting Review Forthcoming
59 Pages Posted: 6 Jun 2016 Last revised: 14 Jan 2020
Date Written: April 6, 2019
This paper empirically examines the association between bank capital and banks’ monitoring effort. We use four proxies to measure the unobservable monitoring effort. Two of the proxies are based on loan quality (ex-post outcomes of monitoring effort). The other two proxies are based on salary expense (ex-ante proxies intended to capture the quality and quantity of labor input into monitoring effort). Using a bank and time fixed effects estimation, we find a positive association between bank capital and each of our measures of monitoring effort. We find that this association is more pronounced for smaller banks and banks that engage in higher levels of relationship lending. Numerous additional tests and robustness checks including matched sample analysis and instrumental variable approach to address endogeneity confirm our main findings. Overall, our evidence is consistent with the prediction in Mehran and Thakor (2011) that banks that keep higher capital monitor more.
Keywords: Bank capital, loan monitoring, loan quality, loan fair values
JEL Classification: G21, G32, M41
Suggested Citation: Suggested Citation