Formal Enforcement Actions and Bank Behavior

Employing a unique data set for the period 2000–2010, this paper examines the impact of formal enforcement actions targeting the core of the banks’ financial safety and soundness in terms of bank capital, risk, and performance. We find that, on average, these actions reduce both the risk‐weighted assets and the nonperforming loans ratios of punished banks, but there is no increase in the level of regulatory capital. These effects are less powerful during the postcrisis period, suggesting that banks’ scope to improve their safety and soundness condition in crisis periods is much more limited. We also find, albeit with some limitations, that the timing of formal enforcement actions is important: the more the actions are deferred relative to the continuous deterioration of the banks’ financial condition, the more limited their impact on the risk‐based capital ratio, while actions taken earlier help banks to improve their financial soundness. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2015.2343. This paper was accepted by Wei Jiang, finance.