Enforcement Actions and Bank Loan Contracting

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Enforcement actions against banks and their management officials are important supervisory instruments that address rule violations, breaches of fiduciary duty, and unsafe or unsound banking practices. But enforcement actions can be costly for banks. Affected banks are sometimes required to pay fines or spend resources to correct violations. In addition, because enforcement actions are publicly announced, they may carry severe reputational costs. In response, some banks may offer borrowers loans with lower interest rates and more favorable terms to compensate for the reputational damage. However, other banks may raise interest rates and offer more stringent terms to reduce risk. Raluca A. Roman investigates the effects of enforcement actions on bank loan contracting to discover which effect dominates. She finds that loans initiated after enforcement actions have statistically and economically significantly lower interest rates than loans initiated before enforcement actions. In addition, non-price loan terms such as maturity and covenant intensity become more favorable for borrowers after an enforcement action.