A Tale of Two Regulators: Risk Disclosures, Liquidity, and Enforcement in the Banking Sector

Abstract

This paper examines the effects of heterogeneity in regulatory supervision on firms’ disclosure behavior and the ensuing capital market consequences. The effectiveness of regulation depends not only on the written rules, but also on how regulators and the firms they regulate enforce and adhere to these rules. We exploit the fact that banks are subject to quasi-identical risk disclosure rules under securities laws (IFRS 7) and banking regulation (Pillar 3 of the Basel II accord), but that different regulators enforce these rules at different points in time. We find that banks substantially increase their risk disclosures upon the adoption of Pillar 3 even if they had to comply with the same requirements under IFRS 7 beforehand. The increase is larger in countries where the banking regulator has more supervisory powers and resources and is less involved in the oversight of securities markets. It is also larger for banks most likely to attract scrutiny from the banking regulator due to distress risk. The improved risk disclosures translate into higher market liquidity around Pillar 3 but not IFRS 7. The results indicate that the success of regulation depends on the institutional fit between regulator and regulated firms, and that having multiple regulators may lead to inconsistent implementation and enforcement of the same rules.