The Death of a Regulator: Strict Supervision, Bank Lending and Business Activity
An important question in banking is how strict supervision affects bank lending and in turn local business activity. Forcing banks to recognize losses could choke off lending and amplify local economic woes. But stricter supervision could also change how banks assess and manage loans. Estimating such effects is challenging. We exploit the extinction of the thrift regulator (OTS) — a large change in prudential supervision — to analyze economic links between strict supervision, bank lending and business activity. We first show that the OTS replacement indeed resulted in stricter supervision of former OTS banks. Next, we analyze the ensuing lending effects. We show that former OTS banks increase small business lending by roughly 10 percent. This increase is not entirely accounted by a reallocation of mortgage lending and stems primarily from well-capitalized banks and those more affected by the new regime. These findings suggest that stricter supervision operates not only through capital but can also overcome frictions in bank management, leading to more lending and a reallocation of loans. Consistent with the latter, we find increases in business entry and exit in counties with greater expose to OTS banks.
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Document Object Identifier (DOI): 10.3386/w24168
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