Borrowing Beyond Bounds: How Banks Pass on Regulatory Compliance Costs

Abstract

Banks in the euro area must inform supervisors about each exposure that exceeds 10% of the bank's capital. Using a granular dataset that combines banks' loan and security portfolios, we test whether banks pass on the cost of complying with the large-exposure framework to borrowers above the threshold. We show that after a decrease in the reporting threshold, small banks react by shifting more exposures just below the threshold. In addition, banks charge a sizable 74 basis point interest rate premium for large exposures, relative to firms just below the threshold. This premium is more pronounced for small banks and unrated borrowers with fewer banking relationships and hence fewer outside options. In response, when firms approach their bank's large exposure threshold, they become more likely to borrow from other banks. Despite the "large-exposure penalty", we find no statistical evidence for bunching below the threshold, suggesting that there are substantial frictions that prevent firms from switching to better-capitalized banks to reduce interest expenses. 

Keywords: Banking, large exposures, AnaCredit, Regression discontinuity design, cost of regulation

JEL Classification: G11, G28