The Effects of Regulatory Office Closures on Bank Behavior

Abstract

AbstractWe investigate if the decentralized structure of regulatory office networks influences supervisory outcomes and bank behavior. Following the closure of an office, banks previously supervised by that office increase their lending and risk‐taking. As a result, affected banks have larger loan losses and higher failure rates during the 2008–09 financial crisis. Analysis of the channels suggests that proximate supervisors enforce timelier provisioning practices, restrict large cash payouts, and provide advice that increases a bank's risk‐adjusted returns. Overall, our findings imply that geographical proximity reduces informational frictions in supervisory monitoring and leads to more stable banks.