Hub-and-Spoke Regulation and Bank Leverage

Abstract

Hub-and-spoke regulation, where a central regulator with legal power over firms delegates monitoring to local supervisors, can improve information collection, but can also lead to agency problems and capture. We document that following the closure of a US bank regulator’s field offices, the banks they previously supervised distribute cash, increase leverage, and increase their risk of failure, more than similar banks in the same time and place. The opposite occurs for openings. Our findings suggest that field level interaction is an important part of regulation, and that distancing supervisors from banks to prevent regulatory capture can increase bank risk.

Keywords: hub-and-spoke, financial regulation, bank supervision, field offices, distance, proximity, regulatory capture

JEL Classification: G21, G28, L51