Bank Supervision and Managerial Control Systems: The Case of Minority Lending

Abstract

This paper investigates how bank supervisors’ enforcement decisions and orders (EDOs) influence the allocation of mortgage lending across demographic groups underlying a banks’ borrower base. Specifically, we investigate how banks’ mortgage lending to minority borrowers relative to white borrowers changes following the resolution of severe EDOs. We hypothesize that improvements in management control systems imposed by EDOs serve as channels through which EDOs affect a bank’s borrower base generally, and minority lending specifically. We empirically examine how changes in loan policies and internal governance mechanisms specified in EDOs influence banks’ mortgage lending decisions. We find that relative to white borrowers, mortgage lending to minority borrowers significantly increases following the resolution of EDOs, where this positive effect increases with the strictness of bank supervisors and severity of the EDO. Consistent with management controls serving as channels for this change, there is a more pronounced effect on minority lending when an EDO mandates improvements in lending policies and stronger internal governance over lending decisions.