Hub-and-Spoke Regulation and Bank Leverage

Abstract

Regulators often delegate monitoring to local supervisors, which can improve information collection, but can also lead to agency problems and capture. We document that following the closure of a US bank regulator's field offices, the banks they previously supervised actively increased their risk of failure by distributing cash, increasing leverage, and lending more than similar banks at the same time and place. Supervisor proximity is a channel through which these effects operate. Our findings suggest that local supervision is an important part of regulation, as it facilitates collection of information imperfectly reflected in reported measures, and that switching from onsite to offsite supervision can increase bank risk.