2017 Community Banking in the 21st Century Research and Policy Conference

Research Papers, Authors and Key Findings

Research Paper Session 1
Supervision, Regulation and Bank Risk

The Effect of Bank Supervision on Risk Taking: Evidence from a Natural Experiment

Authors: John Kandrac, Board of Governors of the Federal Reserve System; Bernd Schlusche, Board of Governors of the Federal Reserve System

Key Findings: In the early 1980s, the vast majority of supervisory employees in the Ninth District of The Federal Home Loan Bank (FHLB), operating out of Little Rock, Arkansas, quit rather than relocate to Dallas, Texas. The authors use this event to study the effects of a reduction in supervisory attention. They find that the affected thrifts increased risky real estate investments and experienced higher-cost failures, relative to thrifts in other districts. They conclude that banking supervision is a vital element of banking policy that has important effects on bank behavior and protects taxpayers from costly failures.

Does Bank Supervision Matter? Evidence from Regulatory Office Closures

Authors: Jens Hagendorff, University of Edinburgh; Ivan Lim, Leeds University; Seth Armitage, University of Edinburgh

Key Findings: The authors use the closure of 11 regional offices of Federal bank regulatory agencies, 1984 to 2013, to study “negative shocks to the efficacy of supervision.” They hypothesize that a shift in the location of oversight from a local (closed) regulatory office to a more distant office increases the costs for examiners to collect and verify bank specific information. They find that banks affected by office closures, relative to unaffected banks operating within the same geographic markets, lend more and are riskier, less profitable and more likely to fail. They conclude, first, that the organizational structure of supervisors is important and, second, that its effectiveness can be can be linked to informational capabilities.

Rules and Judgment in the Oversight of Bank Accounting Practices

Authors: Michelle Neely, Federal Reserve Bank of St Louis; Drew Dahl, Federal Reserve Bank of St Louis; Andrew Meyer, Federal Reserve Bank of St. Louis

Key Findings: The authors analyze how banks of different size adhere to ostensibly “one size fits all” accounting guidelines prescribing that provisions for loan losses anticipate subsequent charge-offs. They find that correlations of provisions and charge-offs are lesser for smaller banks, which they interpret as consistent with a hypothesis that bank regulators are able to reconcile rules and judgment by “tailoring” their supervisory practices to the unique characteristics of community banks. They also find that the exercise of judgment may be associated with greater lending as well as with a greater vulnerability to potential failure.

Risk-insensitive Regulation

Author: Alexander Bleck, Sauder School of Business at the University of British Columbia

Key Findings: This article is a theoretical paper describing how, when a bank has an informational advantage over a bank regulator, it leads to a trade-off: relying on information from banks to refine regulation improves bank risk-taking but also aggravates systemic risk in the banking system and undermines its informativeness. The model explains why the observed relationship between measured risk and actual risk is low. It also shows that when market frictions (information asymmetry and the cost of systemic risk) become more severe, optimal regulation becomes more risk-insensitive.

Reaction to the Supervision, Regulation and Bank Risk Session: Robert DeYoung and Martin Birmingham

Supervision, Regulation and Bank Risk Session: Moderated Q&A

Research Paper Session 2
Factors Influencing Bank Behavior and Performance

Core Profitability of Community Banks, 1985-2015

Author: Jared Fronk, Federal Deposit Insurance Corporation (FDIC)

Key Findings: The author finds that the “core” profitability of community banks has been relatively stable across the thirty-year period ending in 2015. From this perspective, observed declines in returns on assets following the recent financial crisis—which sometimes have been described as dire—are “largely attributable” to the severity of the downturn in macroeconomic factors. He concludes that the fundamental earnings model of community banks remains sound.

Competition and Bank Fragility

Authors: W. Blake Marsh, Federal Reserve Bank of Kansas City; Rajdeep Sengupta, Federal Reserve Bank of Kansas City

Key Findings: The authors find that community banks increase commercial real estate loan holdings, and decrease shares of residential real estate mortgages and consumer loans held, following entry into their markets of larger bank competitors. This is consistent with theories that suggest that, following entry of large banks, community banks lose market share in low-risk, transactions-based retail lending but leverage their knowledge of the local market to focus on relatively riskier activities.

Regulatory Asset Thresholds and Acquisition Activity in the Banking Industry

Authors: Allison Nicoletti, Wharton School of the University of Pennsylvania ; Hailey Ballew, The Ohio State University; Michael Iselin, University of Minnesota

Key Findings: The authors test a hypothesis that compliance costs imposed on banks with assets greater than $10 billion, under the Dodd-Frank Wall Street Reform and Consumer Protection Act, increase the demand for acquisition activity approaching and just above this threshold. Their empirical evidence leads to a conclusion that implementing regulations on the basis of asset thresholds can contribute to consolidation in the banking industry.

Reaction to the Factors Influencing Bank Behavior and Performance Session: Kevin Riley and Allen Berger

Factors Influencing Bank Behavior and Performance Session: Moderated Q&A

Research Paper Session 3
Real Effects of Government Policies

Financial Crises and Filling the Credit Gap: The Role of Government-guaranteed Loans

Author: John Hackney, University of South Carolina, Darla Moore School of Business

Key Findings: The author analyzes the impact of government guarantees on small business lending during the recent financial crisis, during which impacts of financial constraints in private credit markets were pronounced. He finds evidence that, within a given geographic market, the number of bank branches offering loans guaranteed by the Small Business Administration is positively associated with market growth in small business loans. This growth, moreover, increases employment at the smallest firms but does not increase defaults on loans.

The Real Effects of Geographic Lending Disclosure on Banks

Authors: Yiwei Dou, New York University; Youli Zou, George Washington University

Key Findings: Community organizations leverage access to the geographical distribution of loans mandated by the Community Reinvestment Act (CRA) to press for lending under its requirement that banks meet local credit needs. The authors examine the 2005 exemption of this disclosure mandate and find that banks that take the exemption, relative to those that do not, experience a reduction in non-performing loans. They conclude that mandatory disclosure for some banks results in a “deterioration” of loan underwriting quality.

Color and Credit: Race, Regulation and the Quality of Financial Services

Authors: Taylor Begley, Washington University in St. Louis; Amiyatosh Purnanandam, Ross School of Business, University of Michigan

Key Findings: The authors find that the quality of services provided to bank customers is lower in markets with lower incomes and higher minority populations. They also find that requirements under the Community Reinvestment Act to increase the quantity of services have an unintended consequence of lowering the quality of services delivered, which is consistent with incentives for banks to dilute quality when quantity is regulated.

Reaction to the Real Effects of Government Policies Session: Peter Schork and Tim Yeager

Real Effects of Government Policies Session: Moderated Q&A