The disciplining effect of bank supervision: evidence from SupTech

Summary

Focus

Regulatory enforcement is a cornerstone of financial stability. Failures in regulatory oversight have historically contributed to major financial crises, including the 2007–08 Great Financial Crisis and the 2023 banking turmoil. In response, regulators worldwide have shifted from compliance-based to risk-based bank supervision, supported by the development and implementation of supervisory technologies (suptech). These technologies aim to identify and address financial distortions before they can materialise and threaten financial stability. Despite the increasing implementation of suptech tools by financial authorities across the globe, it remains unclear whether such risk-based supervisory tools can effectively discipline risky bank behaviour. Our paper addresses this question using unique data from the Central Bank of Brazil – a pioneer in the adoption of suptech.

Contribution

Our paper builds upon prior studies on the real effects of bank supervision and the design of supervisory frameworks in the banking sector. It provides the first empirical analysis of how suptech tools – and risk-based supervision more broadly – affect  bank risk-taking. It also offers novel evidence on the role of moral suasion – long recognised as a key element of the supervisory toolkit – in bank supervision.

Findings

Our empirical analysis uses a difference-in-differences model to compare banks subject to suptech events with those that are not, before and after the events. Our findings are threefold. First, after a suptech event, affected banks reclassify more loans as non-performing and increase provisions for expected loan losses, suggesting that they reveal previously hidden credit risks. Second, suptech events prompt banks to reduce credit to less creditworthy borrowers, thereby improving the quality of their loan portfolios. Third, we show that this credit tightening has a small impact on the economic activity of less creditworthy firms and that the overall spillover effects on the real economy are limited. These findings appear to be driven by a moral suasion channel, whereby supervisory scrutiny enhances banks' understanding of the regulator's supervisory views and encourages more conservative risk management practices aligned with those views. Overall, our study provides novel evidence of the role of suptech in bank supervision, with valuable policy implications.

Abstract

Regulators increasingly rely on supervisory technologies (SupTech) to enhance bank supervision, but their potential role in disciplining bank behavior remains unclear. We address this knowledge gap using unique data from the SupTech application of the Central Bank of Brazil. We show that, after a SupTech event, banks reveal inconsistencies in their risk reporting and tighten credit to less creditworthy firms, effectively reducing risk-taking. This credit tightening in turn has small spillovers on less creditworthy firms borrowing from affected banks. Our results can be explained by a moral suasion channel, offering novel insights into the role of SupTech in bank supervision.

JEL classification: G21, G28

Keywords: bank supervision, SupTech, bank risk-taking, bank lending, real effects