Emerging insights in banking regulation & transparency

Cost-shifting under regulatory opacity

In this paper, Corell & Papoutsi analyze non-public supervisory transparency, where banks must confidentially report exposures exceeding 10% of Tier 1 capital to regulators. Their focus is on how regulatory opacity (non-disclosure to the public) enables banks to pass compliance costs to borrowers. In particular, the authors look at the LEX framework which mandates banks to report large exposures to supervisors but does not require public disclosure.

• Methodology
  -The authors use a regression discontinuity design (RDD) to analyze the impact of the EU’s Large Exposure (LEX) reporting threshold (10% of Tier 1 capital) on loan pricing.
  – They compare interest rates for exposures just above/below the 10% threshold, exploiting the regulatory cutoff as a natural experiment.
• Data sources
  – For supervisory data the authors combine AnaCredit (European credit register for loan exposures), Security Holdings Statistics (SHSG) for bond/equity exposures, and bank-level financials (Tier 1/Tier 2 capital, total assets).
  – The focus is on non-financial corporations (NFCs) as borrowers to avoid confounding effects from derivatives or financial sector exposures.

Key findings

1. Cost pass-through:
   – Banks charge a 74 basis point (bps) premium on loans above the LEX threshold, transferring compliance costs to borrowers.
   – Premium increases to 146 bps for small banks (total assets < 25th percentile).
2. Heterogeneity:
   – Unrated firms and those with fewer banking relationships (median = 2) pay higher premiums due to weaker bargaining power.
   – Effects are absent in syndicated loans, where banks lack pricing discretion.
3. Market frictions:
   – No evidence of “bunching” below the threshold, indicating firms face switching costs that prevent efficient substitution to better-capitalized banks.
   – Firms near the threshold are 14.5% more likely to seek new lenders, but frictions limit reallocation.
4. Event study:
   Banks subjected to a 2019 reform (lowering the LEX threshold) experienced significant stock price declines, especially those with higher Tier 2 capital.

Corell & Papoutsi conclude that non-public supervisory reporting creates information asymmetry, allowing banks to externalize compliance costs to vulnerable borrowers (e.g., SMEs).  While LEX regulation reduces systemic risk, its design disproportionately burdens small banks and regional borrowers.

Borrowing Beyond Bounds: How Banks Pass on Regulatory Compliance Costs
Authors: Felix Corell, Melina Papoutsi
From: VU University Amsterdam, European Central Bank

The transparency dividend

Beyer & Dautović study public supervisory transparency, where Pillar 2 Requirements (P2Rs) are disclosed to market participants. Their focus is on how transparency resolves adverse selection and improves market discipline.

• Methodology
  – The authors employ a difference-in-differences (DiD) approach to compare funding costs for banks that disclosed Pillar 2 Requirements (P2R) (“transparent”) versus those that did not (“opaque”) before/after the 2021 EU disclosure mandate.
  – They exploit the staggered adoption of P2R transparency rules across eurozone countries.
  – They control for self-selection bias (e.g., better-performing banks voluntarily disclosing P2R) using bank fixed effects and robustness checks (propensity score matching).
• Data Sources
  For supervisory and financial data the authors combine hand-collected P2R disclosures (2017–2020), ECB supervisory metrics (SREP assessments, COREP/FINREP filings), and bank-level financials (interest expenses, total liabilities, CET1 ratios).

Key findings

1. Market efficiency gains:
   – Transparent banks experience 11.5% lower funding costs on average compared to opaque peers.
   – Safest quartile (CET1 P2R < 1.5%) benefit most, with 31.1% lower funding costs, reflecting accurate risk pricing.
2. Opacity-driven distortions:
   – Opaque banks exhibit adverse selection: Riskier banks (higher P2R) paradoxically enjoy lower funding costs due to information asymmetry.
   – Transparency resolves this by aligning funding costs with supervisory risk assessments.
3. Heterogeneity:
   – Effects are strongest for smaller banks and those in high-information-asymmetry markets.
   – Custodian banks and institutions in jurisdictions with strict confidentiality laws show muted transparency benefits.
4. Policy impact:
   – Mandatory P2R disclosure (CRR2) corrected market failures, reducing funding cost dispersion (σ fell by 31%).
   – Transparency enhances supervisory accountability and investor confidence.

Beyer & Dautović highlight the dual role of transparency: resolving market failures while reinforcing supervisory credibility and financial stability. They also advocate for tiered transparency frameworks to address heterogeneity in bank risk profiles and jurisdictional legal constraints.

Bank transparency and market efficiency
Authors: Andreas Beyer, Ernest Dautović
From: ECB

Complementarities and differences between both working papers

Complementarity: Both studies underscore transparency’s role in aligning costs with risk. Corell & Papoutsi highlight distortions from supervisory opacity, while Beyer & Dautović show market corrections under public transparency.

Differences: Public transparency (P2R) mitigates adverse selection, whereas non-public transparency (LEX) exacerbates it by creating information asymmetry between banks and borrowers.