Do regulatory penalties reduce risk-taking of banks?

This paper analyzes the impact of regulatory penalties on risk-taking of Chinese commercial banks during the period of 2009-2019. Our results reveal that regulatory penalties significantly reduce bank risk-taking, and the results still hold after taking endogeneity and robust tests into consideration. As mechanism test uncovers, regulatory penalties exert much pronounced effect on banks with better corporate governance and stronger market discipline. Furthermore, regulatory penalties enforce banks to improve asset structure in which the proportion of quasi-credit shadow-banking activities has decreased. On the other hand, the structure of bank lending also has changed by penalties with more funds flowing to the real estate sector, and less to the manufacturing sector. Based on those, this paper proposes to optimize regulatory penalty designation further, with the goal of stabilizing bank operating, reducing risk exposure, and providing better financial service for high-quality development in real sector.