Regulatory discretion and banks’ pursuit of “safety in similarity”.pdf

BIS Working Papers No 235 Regulatory discretion and banks’ pursuit of “safety in similarity” by Ryan Stever and James A Wilcox Monetary and Economic Department August 2007 BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The views expressed in them are those of their authors and not necessarily the views of the BIS. Copies of publications are available from: Bank for International Settlements Press Communications CH-4002 Basel, Switzerland E-mail: publications@ Fax: +41 61 280 9100 and +41 61 280 8100 This publication is available on the BIS website (). © Bank for International Settlements 2007. All rights reserved. Limited extracts may be reproduced or translated provided the source is stated. ISSN 1020-0959 (print) ISSN 1682-7678 (online) Abstract We propose that individual banks’ reported loan losses and provisions for future loan losses are lower, all else equal (including their own financial statements), when the banking industry is weaker. We further hypothesize that this option of underreporting charge-offs and provisions provides banks with incentives, when the banking industry is weaker, to cluster more, or to seek “safety in similarity.” We provide evidence that large, individual U.S. banks indeed tend to report both lower charge-offs and lower provisions for loan losses, after controlling for their other determinants, when the banking industry is weaker. We also show that banks tend to be more clustered, or similar, when the industry is weaker. In addition, individual banks change their risk-taking to make it more similar to that of banking industry averages, and change it faster, when the industry is wea