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Since the recent financial crisis, two particular noteworthy phenomena have arisen in the U.S. banking industry. First, authors have observed an increase in activities to exert influence on regulation and supervision, such as lobbying, campaign contributions, and wielding political connections, throughout the financial industry. Second, authors have seen the financial industry receiving wide-spread support from its regulators and governments in many countries. Moreover, there seems to be strong variation in the way banks were treated: While the regulatory rules and standards were rigorously applied to some banks, more discretion was exercised for others. To better understand the interaction between the financial industry and their regulators and supervisors, we intend to investigate these two phenomena further. Authors address a series of relevant questions by exploring if and how banks’ sources of influence drive the expectation of government support to banks and the actual regulatory treatment of banks once they encounter financial difficulties.
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First, authors investigate whether banks’ sources of influence reduce the chances of receiving a PCA and provide evidence for the effective impact of these sources on the regulatory treatment of distressed banks. The results show that banks that have lobbied in the past and fall below the undercapitalized threshold have a 12% lower probability of receiving additional discretionary actions. The economic size and significance of banks’ influence exertion is similar when authors test proximity to relevant subcommittee members and prior regulatory or government affiliations of board members. Then, authors examine expected government support and find that past lobbying activities and other sources of influence lead to an improvement of about 1.6 points in the current rating compared to banks that do not engage in influence exertion. Economically speaking, this effect is significant, as researchers at the IMF have shown that banks with better support ratings enjoy an “implicit subsidy” in the form of cheaper funding costs.
The effects authors find hold for alternative explanations and specifications, i.e., different timelines, alternative definitions of lobbying activities, and alternative estimation models. For instance, authors test for systematic differences between banks with and without political influence that might justify the diverging regulatory treatment. The results of these tests are in line with their initial findings, implying that there are no significant differences which might impact their results. Moreover, authors examine whether their results suffer from reversed causality. [...]
Several conditions even further increase the effectiveness of banks’ influence exertion: The probability of a more preferential treatment in distress increases with lobbying expenditures, but authors prove even small amounts to be effective, suggesting that the magnitude of lobbying expenditures is not crucial but rather the existence of a channel between the bank and the lobbied institution. Besides lowering the probability of obtaining additional discretionary measures, authors show that lobbying activities decelerate the propensity for additional sanctions with deteriorating capital ratios. Engaging a former member of congress as lobbyist and campaign contributions from the financial industry to legislative committee representatives are found to amplify the favourable treatment. However, there seems to be a limit to the efficacy of influence when it comes to closure decisions. Lobbying and other sources of political influence are no longer effective in averting bank closure when banks are in deep financial distress.