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

• In Event: Bank Regulation

Abstract

An important question in banking is whether stricter supervision, especially in response to financial crises, improves the allocation of financial resources and boosts economic recovery. It could also choke off lending and amplify recent economic woes. However, estimating the effects of strict supervision is challenging. We exploit the extinction of the thrift regulator (OTS) – an unprecedented change in prudential supervision, affecting ten percent of all U.S. depository institutions. Using this event, we analyze the economic links between strict prudential supervision, bank lending and business activity. We first show that the OTS replacement indeed
resulted in stricter supervision and enforcement of financial rules in former OTS banks. We then analyze the effects of stricter supervision and show that former OTS banks increase small business loans originations by roughly 15 percent. We also find increases in business dynamism (entry and exit) in counties most exposed to OTS banks, suggesting that the increase in business lending leads to a reallocation across new and old establishments. When we explore the
mechanism for the lending results, we find that stricter supervision also affects well-capitalized banks, indicating it is not only bank capital that is holding back new lending by banks with nonperforming
loans.

Authors

• Joao Granja, University of Chicago

• Christian Leuz, The University of Chicago