NEW YORK, NY – The collapse of Silicon Valley Bank has led to scrutiny among lawmakers and regulators about what led to the bank’s failure and raised questions about what regulatory reforms might be needed to avoid future bank collapses. Although banks continue to lobby for less regulation and restrictions, the recent bank failures show that regulations requiring capitalization and other measures are vital. Research from Columbia Business School Professor Kairong Xiao shows that banks are able to get around regulations by asserting high regulatory costs to advocate for deregulation. Banks’ self-reported regulation costs may significantly exceed the actual costs inferred from their actions and go without notice from regulators.
In Watch What They Do, Not What They Say: Estimating Regulatory Costs from Revealed Preferences, published in February 2022, Columbia Business School Professor Xiao and doctoral graduates Adrien Alvero and Sakai Ando compared the data of regulatory costs publicly reported by banks before and after the passage of the Dodd–Frank Act of 2010, which imposes more regulations on banks when their assets cross the $10 billion and $50 billion thresholds. The team analyzed 19 years of bank reports, including the call reports of commercial banks and the FRY-9C reports for bank holding companies. Findings show banks shrink their assets to avoid regulations, creating bunches around the thresholds. These distortions are not present before Dodd–Frank, nor are they present around other round numbers that are not regulatory thresholds, such as $20 billion or $40 billion. The extent of this regulatory avoidance can reveal the regulatory costs shouldered by banks: a more pronounced bunching implies higher regulatory costs.
Through their analysis, the authors find that a bank with $50 billion in assets is experiencing a yearly regulatory cost of 0.52% of average annual profits. This means that banks are paying significantly less in regulatory costs than what they are estimating in surveys – for instance, banks reported in a 2017 survey conducted by Bank Director Magazine that the annual regulatory costs are around 9.9% of banks’ annual profits, while another from the American Action Forum from 2016 found that banks reported regulatory costs of 1.8%.
After the recent bank failures, banks are now highly anticipating regulatory changes to be implemented. Financial regulators and lawmakers can apply the findings of this paper to extract valuable information by analyzing banks’ response to regulations and help determine and enforce more accurate regulatory solutions to avoid future financial disasters.
You can read the full study on the IMF.org site.
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