The impact of community banks’ innovation on regulatory choices

Abstract

Launched in 2019, the Community Bank Leverage Ratio (CBLR) framework is a new regulation designed to reduce US community banks’ regulation burden. However, evidence has shown that only a minority of banks have voluntarily adopted this new regulation. Applying the Two-stage least squares-Instrumental variables method to analyze 4037 US community banks, we find out that the reduced likelihood of opting into the CBLR could be attributed to the insufficient bank innovation. Lack of innovation may reduce banks’ motivation to simplify reporting, reflect relatively few risky activities, and hold lower capital level, which prevents community banks from participating in this non-risk-based regulation framework. Moreover, compared to product innovation and process innovation, technological innovation has the most advanced impact on bank decision, and the influence is more pronounced in banks charted by federal authority. There also exists a bidirectional positive effect between the adoption of CBLR and bank innovation, where higher innovation level leads to higher CBLR adoption likelihood, and the CBLR adoption, in turn, accelerates the bank innovation and overall bank performance. Our findings remain robust across alternative variable measurements, estimation methods, model specifications, and various control variables.