Essays on banking

Abstract

This thesis consists of three essays on banking in the U.S. The first two chapters study how supervisors and regulators influence bank behavior. The third chapter explores how bank CEOs allocate credit. The first chapter uses a quasi-natural experiment, the closure of regulatory offices, to identify the effects of supervision on bank behavior. Under the decentralized structure of U.S. bank supervision, banks in the same geographic area may be supervised by different regulatory offices. The chapter shows that, following the closure of a regulatory office, banks previously supervised by that office increase their solvency risk and lending compared with banks in the same counties that are supervised by a different regulatory office. Further, these banks exhibit lower risk-adjusted returns, lower asset quality, and opportunistic provisioning behavior for loan losses. Information asymmetry between banks and supervisors partly explains the results. The second chapter documents that nearly 30% of U.S. banks employ at least one board member who currently or previously served on a regulator’s advisory council or on the board of a regulator as a form of public service. The chapter shows that connections to regulators undermine regulatory discipline by decreasing the sensitivity of bank risk to capital. Connected banks are able to extract larger public subsidies than non-connected banks by shifting risk to the financial safety-net, resulting in wealth transfers from taxpayers to shareholders of risk-shifting connected banks. One potential reason for these effects is that connected banks receive preferential treatment in supervision from regulators. The third chapter uses the birthplace of U.S. bank CEOs to investigate the effect of hometown favoritism on bank business policies. Exploiting within-bank variation in distances to a CEO’s hometown, the chapter shows that banks make more mortgage and small business lending as well as branch expansions in counties that are proximate to the hometown of the CEO. This is due to the CEO’s altruistic attachment to her hometown; the effects are stronger during economic downturns, among altruistic CEOs, in poorer counties and marginal mortgage applicants. Further, hometown favoritism does not lead to worst bank performance. However, it is associated with positive economic outcomes in counties exposed to greater favoritism.