The Unintended Effects of Regulatory Penalties in the Banking Sector

【Authors】

GONG Di, ZHANG Zhixuan & LI Guangzi

【WorkUnit】

GONG Di, ZHANG Zhixuan (University of International Business and Economics, 100029)；LI Guangzi (Chinese Academy of Social Sciences/NIFD, 100710/100020)

【Abstract】

This study investigates whether regulatory penalties imposed on banks inadvertently increase corporate borrowing costs—an unintended consequence of otherwise well-intentioned financial supervision. While existing literature confirms that penalties effectively curb bank risk-taking, their potential spillover effects on the real economy remain underexplored. We address this gap by integrating the “regulator-bank-firm” triad into a unified analytical framework to examine if and how penalized banks pass regulatory costs to corporate borrowers through higher loan pricing. 
We propose two primary transmission mechanisms. Under the risk compensation mechanism, penalties heighten banks’ risk aversion, prompting them to demand higher premiums from risky borrowers. Under the cost compensation mechanism, direct fines and indirect funding cost increases, stemming from reputational damage and higher funding expenses in interbank markets, motivate banks to shift these burdens onto clients.
Using a novel dataset combining regulatory penalty records from China’s National Financial Regulatory Administration with detailed loan contract data of A-share listed firms from 2012 to 2020, we employ high-dimensional fixed effects models. Our findings show that penalized banks significantly increase loan spreads. A one-standard-deviation rise in penalty intensity raises corporate loan rates by approximately 4 basis points. These results are robust to tests, including instrumental variable estimation and a difference-in-differences analysis exploiting a 2015 regulatory reform.
Mechanism tests confirm both channels: penalized banks increasingly demand collateral and charge higher rates specifically to small, non-state-owned, and high-risk firms; they also face elevated interbank funding costs. Heterogeneity analyses reveal that the pass-through effect is concentrated in banks with high loan portfolio concentration, while greater banking competition and positive media coverage of borrowing firms can mitigate the pass-through effect.
Our findings yield the following policy implications. Regulators should balance disciplinary objectives against real-economy spillovers, banks should manage concentration risk, and firms can buffer financing shocks by enhancing transparency and building corporate reputation. This study contributes to the literature by uncovering a significant, unintended consequence of financial supervision in credit markets, opening avenues for future cross-country comparisons and investigation into long-term effects of financial supervision.

JEL: G21, G28, G32

【KeyWords】

Financial Supervision, Regulatory Penalty, Lending Rate, Commercial Banks