Reducing banking regulation creates shareholder value and positive stock returns – London Business News

Reducing regulation around banking activities creates shareholder value and positive stock market returns, finds new research from Nyenrode Business University and the Erasmus School of Economics.

Dr Michael Erkens, Professor of Corporate Reporting at Nyenrode and the Erasmus School of Economics, and Professor Ying Gan of the Erasmus School of Economics studied the responses of US-based banks and shareholders to feedback back from the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

The law brought the banking industry under greater federal oversight in an effort to ensure financial stability after the 2007-2008 global financial crisis.

According to the authors, the deregulatory measures coincided with positive abnormal stock returns, improvements in capital strength and accounting performance, and an expansion of external financing and lending activities.

Indeed, high compliance costs have limited banks’ business activities and discouraged growth, according to the authors. They suggest banks have slowed their asset growth to stay below the two thresholds ($10 billion and $50 billion) that determine the extent of regulations under Dodd-Frank.

The results also suggest that small banks (with assets below $10 billion) and large banks (with assets above $50 billion) are affected and respond differently to deregulation. For smaller banks, the setbacks mainly included the repeal of tougher business rules and a relaxation of mortgage underwriting standards. Large banks mainly benefited from exemptions from capital requirements and stress tests. Thus, positive asset growth following the easing of restrictive measures was only seen in small banks.

“The relaxation of regulation for large banks probably makes smaller banks more willing to expand again and cross the $10 billion threshold. We find that shareholders of smaller banks react more favorably to deregulation. The difference in reaction suggests that smaller bank investors expect greater shareholder value creation from less restrictive financial supervision,” Dr. Erkens said.

Dr Gan added that “the positive business outcomes for smaller banks demonstrate the potential practical relevance of significantly reducing regulatory burden and compliance costs.”

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Michael C. Sumner