Regulatory profiling and endogenous benchmarking

Banks' responses to regulatory requirements have a direct effect on their balance sheet mix and their business models. The paper introduces the concept of regulatory profiling, which establishes a nexus between banks' operations and their regulatory choices. Regulatory profiling is a process that identifies an optimal number of regulatory peers sharing similar operational characteristics for a bank. We also introduce a novel methodology for identifying the optimal direction of improvement in bank operations through Principal Components Pursuit, thereby overcoming restrictive shortcomings of competing approaches. This methodology identifies the core operations within each regulatory profile, which are effectively projections of the actual operations, and uses the projected points as optimal directions of improvement. Using data from US commercial banks following the Dodd-Frank Act's relaxation, we find empirical evidence of convergence in operations while controlling for banks' regulatory responses. Core banking operations shift towards a safer mode of operations, arguably to improve capital adequacy. Our findings are validated for banks' risk and profitability while carry important policy implications, since regulatory profiling seems to matter the most for smaller banks.