Is Bank Regulation Effective from Afar?

Abstract

We study how geographic distance affects bank regulatory monitoring and its flow on effect to borrowing firms' risk-taking. Using a sample of 304 Chinese commercial banks over the period 2007 to 2020, we find that banks monitored by a distant regulator take on additional risk in terms of lower capital ratios and more non-performing loans. Our firm-level analysis shows that firms borrowing from banks that are further away from regulators also take on more risk. These results indicate that geographic distance between banks and their regulators increases the information costs and thus diminishes regulatory effectiveness. Such ineffective monitoring leads to more risk taken through lax lending, which in turn causes borrowing firms to take on more risks in their own operations.

Keywords: Information costs, geographic distance, bank regulation, risk-taking