Federal banking regulators' competition in laxity: Evidence from CRA audits

The U.S. banking industry has three federal regulators in addition to the 50 state regulators. Through choices regarding its chartering source, joining the Federal Reserve System, and having deposit insurance, a bank also selects which office or agency serves as its primary regulator. Federal regulators gain status and authority from the number of banks over which they have primary supervision. It has long been suspected, therefore, that they compete with each other to entice banks to make choices that increase the number of banks reporting to them. This competition which includes less stringent enforcement and broad interpretation of the laws as favored by the banks is known as competition in laxity. The Community Reinvestment Act (CRA) is enforced by each of the three federal banking regulators. Since 1990, their ratings of banks' CRA performance have been published. This published data provides an opportunity to test accuracy of the competition in laxity theory.