The Real Effects of Bank Supervision: Evidence from On-Site Bank Inspections

87 Pages Posted: 3 Nov 2020

See all articles by Andrea Passalacqua

Andrea Passalacqua

Board of Governors of the Federal Reserve System

Paolo Angelini

Bank of Italy

Francesca Lotti

Bank of Italy

Giovanni Soggia

affiliation not provided to SSRN

Date Written: May 15, 19

Abstract

We show that bank supervision reduces distortions in credit markets and generates positive spillovers for the real economy. Combining a novel administrative dataset of unexpected bank inspections with a quasi-random selection of inspected banks in Italy, we show that inspected banks are more likely to reclassify loans as non performing after an audit. This behavior suggests that banks are inclined to misreport loan losses and evergreen credit to underperforming firms unless audited. We find that this reclassification of loans leads to a temporary contraction in lending by audited banks. However, this effect is completely driven by a credit cut to underperforming firms, as the composition of new lending shifts toward more productive firms. As a result, these productive firms increase employment and invest more in fixed capital. We provide evidence of a mechanisms for our results: a change in bank governance. Finally, we find positive spillovers from inspections: entrepreneurship increases, underperforming firms are more likely to exit the market, and there is an overall increase in productivity in the local economy as a result. Taken together, our results show that bank supervision is an important complement to regulation in improving credit allocation.

Keywords: Bank Supervision, On-site Inspections, Misallocation, Zombie Lending, Real Effects, Firm Productivity

JEL Classification: G21, G28, E44, E51, D22, O47

Suggested Citation

Passalacqua, Andrea and Angelini, Paolo and Lotti, Francesca and Soggia, Giovanni, The Real Effects of Bank Supervision: Evidence from On-Site Bank Inspections (May 15, 19). Available at SSRN: https://ssrn.com/abstract=3705558

Andrea Passalacqua (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Paolo Angelini

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Francesca Lotti

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

Giovanni Soggia

affiliation not provided to SSRN

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