The Effect of Bank Supervision on Risk Taking: Evidence from a Natural Experiment
54 Pages Posted: 22 Mar 2017 Last revised: 16 Jan 2019
Date Written: January 15, 2019
We exploit an exogenous reduction in bank supervision to demonstrate a causal effect of supervisory resources on financial institutions' willingness to take risk. The additional risk took the form of more risky loans, faster asset growth, and a greater reliance on low quality capital. This response to less supervision boosted banks' odds of failure. Lastly, we identify channels by which the reduction in supervisory capacity led to more costly failures relative to unaffected areas. None of these patterns are present in depository institutions subject to a different supervisor but otherwise similar to the banks in our sample.
Keywords: Bank Supervision, Risk Taking, S&L Crisis, Lending, Resolution Costs
JEL Classification: G01, G21, G28
Suggested Citation: Suggested Citation