Regulators vs. Markets: Do Differences in Their Bank Risk Perceptions Affect Lending Terms?

Abstract

We quantify the differences between market and regulatory assessments of bank portfolio risk, showing that larger differences significantly reduce corporate lending rates. Specifically, to entice borrowers, banks reduce spreads by approximately 4.1% following a one standard deviation increase in our measure for bank asset-risk differences. This amounts to an interest income loss of USD 1.95 million on a loan of average size and duration. The separate effects of market and regulatory risk are much less potent. Our study reveals a disciplinarycompetition effect in favor of corporate borrowers when there is information asymmetry between investors and bank regulators.