Economic Consequences of Mandatory Auditor Reporting to Bank Supervisors

We study the economic consequences of mandates that require bank auditors to report to bank supervisors. Based on survey responses from the European Central Bank and all 28 national bank regulators within the European Union and a review of national banking regulations, we create a novel dataset of the extent of these mandates. Exploiting the cross-sectional and time-series variation in these mandates, we investigate the effects of mandated auditor reporting on bank risk. We find evidence that auditor reporting reduces bank riskiness, as measured by counterparty risk, nonperforming loans, and credit spreads. We also observe a decline in risk-weighted assets, which suggests that mandated auditor reporting enhances the effectiveness of regulatory supervision. In addition, we find that improvements to the supervisory review process and to banks' information environment support enhanced market discipline. Finally, mandated auditor reporting comes with costs: it reduces future lending growth and profitability, as well as increases audit fees paid by shareholders