Bank Capital and Loan Monitoring
The Accounting Review · 2020 · Volume 95 · Issue 3
Abstract
This paper empirically examines the association between bank capital and banks' monitoring effort. We use four proxies to measure the unobservable monitoring effort. Two of the proxies are based on loan quality (ex postoutcomes of monitoring effort). The other two proxies are based on salary expense (ex anteproxies intended to capture the quality and quantity of labor input into monitoring effort). Using a bank and time fixed effects estimation, we find a positive association between bank capital and each of our measures of monitoring effort. We find that this association is more pronounced for smaller banks and banks that engage in higher levels of relationship lending. Numerous additional tests and robustness checks, including matched sample analysis and instrumental variable approach to address endogeneity, confirm our main findings. Overall, our evidence is consistent with the prediction inMehran and Thakor (2011)that banks that keep higher capital monitor more. JEL Classifications:G21; G32; M41.
Keywords
bank capital, bank monitoring, loan quality
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