The Death of a Regulator: Strict Supervision, Bank Lending and Business Activity

82 Pages Posted: 28 Dec 2017 Last revised: 14 Apr 2022

See all articles by Joao Granja

Joao Granja

University of Chicago - Booth School of Business

Christian Leuz

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); Leibniz Institute SAFE; European Corporate Governance Institute (ECGI); Center for Financial Studies (CFS); CESifo Research Network

Multiple version iconThere are 3 versions of this paper

Date Written: March 31, 2022

Abstract

An important question in banking is how strict supervision affects bank lending. Supervisors forcing banks to recognize losses could choke off lending and amplify local economic woes. But strict supervision could also change how banks assess and manage loan portfolios and credit risk. Estimating such effects is challenging. We exploit the extinction of the thrift supervisor (OTS) to analyze the effects of strict supervision on bank lending and bank management. We first show that the OTS replacement indeed resulted in stricter supervision of former OTS banks. Next, we analyze the ensuing lending effects and show that former OTS banks on average increase small business lending by roughly 10 percent. This increase is concentrated in well-capitalized banks and especially those that changed bank management practices following the supervisory transition. We also show that the supervisory-induced increase in credit supply is not fully explained by a reallocation from mortgage to small business lending after the crisis and does reflect risk shifting to cope with shrinking margins. These findings suggest that stricter supervision operates not only through capital but can also correct deficiencies in bank management and lending practices, extending credit supply.

Keywords: Bank regulation, Enforcement, Loan losses, Aggregate outcomes, Prudential oversight, Business lending, Entry and exit

JEL Classification: E44, E51, G21, G28, G31, G38, K22, K23, L51, M41, M48

Suggested Citation

Granja, Joao and Leuz, Christian, The Death of a Regulator: Strict Supervision, Bank Lending and Business Activity (March 31, 2022). European Corporate Governance Institute (ECGI) - Law Working Paper No. 447/2019, LawFin Working Paper No. 4, Available at SSRN: https://ssrn.com/abstract=3092284 or http://dx.doi.org/10.2139/ssrn.3092284

Joao Granja

University of Chicago - Booth School of Business ( email )

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Christian Leuz (Contact Author)

University of Chicago - Booth School of Business ( email )

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HOME PAGE: http://faculty.chicagobooth.edu/christian.leuz/

National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Leibniz Institute SAFE ( email )

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European Corporate Governance Institute (ECGI)

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Belgium

HOME PAGE: http://www.ecgi.org

Center for Financial Studies (CFS) ( email )

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Germany

CESifo Research Network

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