Sabbatical Seminar: Supervision and the Liquidity-Lending Tradeoff

co-authors: Elena Carletti&Alberto Manconi (Bocconi and CEPR) and Isabella Wolfskeil (Fed Board)

Abstract: We study how regulation and supervision interact to affect bank risk. Exploiting the 2018-2019 U.S. bank deregulation, we show that mid-sized banks subject to relaxed liquidity requirements experienced a deterioration in liquidity, but an expansion of lending. At the same time, using confidential data from the Federal Reserve on supervisory hours, we document that these banks were subject to more intense supervision, with an increase in examination activity. Our evidence suggests that the increase in supervisory intensity mitigates the liquidity deterioration at the expense of lower lending. These effects are stronger in districts where supervisors oversee fewer banks and have longer tenure. These results underscore the complementary roles of regulation and supervision and suggest that preserving supervisory capacity affects the tradeoff between lending and liquidity regulation.