Unintended Consequences of the Increased Asset Threshold for FDICIA Internal Controls: Evidence from US Private Banks

We examine the unintended consequences of the 2005 increase in the asset threshold for FDICIA internal control reporting requirements from $500 million to $1 billion. We focus on a test sample of banks that grew from between $100 million to $500 million in assets prior to the change in regulation to between $500 million and $1 billion in assets within two years following the change. These banks are no longer subject to the internal control requirements but would have been had the regulation not changed. We find that this sample of “affected” banks grew rapidly by taking on highly risky loans in the period preceding the financial crisis. During the crisis period, we document that these banks had higher likelihood of failure and higher likelihood of financial trouble, as reflected in large losses (poor performance), large loan loss provisions (low asset quality), and low capital (low balance sheet strength). We also find that auditor reputation (i.e., whether the bank had a Big 4 auditor) had a moderating effect on the likelihood of bank failure and bank trouble for these banks.