Does regulatory bank oversight impact economic activity? A local projections approach

Existing research generally finds that the magnitude of the effect of supervisory rating shocks on real economic activity is small and short-lived. This finding is puzzling because downgrades, especially substantial ones, often include lending restrictions and thus would be expected to have a strong effect on real activity. We use the local projections approach to investigate whether this anomaly can be explained by nonlinearities or asymmetric effects; our empirical results indicate that they are indeed present. In particular, we find that the effects are asymmetric: bank downgrades lead to a pronounced decline in real activity, while upgrades do not result in its increase. Furthermore, we document the presence of nonlinear effects for the downgrade—but not upgrade—shocks, as their impact increases disproportionately with its size.