Stressed Banks

We investigate the risk-taking of stressed banks, that is the large financial institutions that have faced unprecedented regulatory supervision and capitalization requirements. We take steps to- ward identifying how supervision affects risk-taking in the banking system. In the Dodd–Frank Act, supervision distinctly improves borrowers’ ratings by 0.7 rating classes. Banks respond to supervision heterogeneously, depending on the capital charges associated with their investments. Ignoring the confounding effect of capital requirements leads to the erroneous conclusion that supervision under the Dodd–Frank Act is ineffective. Our results indicate that stressed banks improve financial stability because they are better capitalized and engage in safer lending.