Does Distance Impede Regulatory Monitoring? Evidence from the Banking Industry

We examine how the information environment influences bank regulatory monitoring. Using the distance between banks and regulatory field offices as a proxy for information asymmetry, we show that an increase in distance reduces the quality of financial reporting. To establish causality, we use a quasi-natural experiment that exploits multiple exogenous shocks to distance, an instrumental variable approach as well as the enactment of the FDICIA Act of 1991 as a shock to the information environment. We provide evidence that regulators make use of local informational advantages to enforce better quality financial reporting. We further show that despite informational advantages, regulators choose when to increase regulatory scrutiny and chose not to do so during the financial crisis. Overall, our study underscores the importance of local information in regulatory monitoring