Weathering the Storm: Does Voluntary Auditing Forestall Regulatory Sale or Closure of Troubled Community Banks?

SUMMARY Using a unique sample of small community banks, we investigate effects of voluntary audits on the likelihood of regulatory sale or closure. In two samples of banks at heightened risk for this final regulatory intervention, we find a decreased likelihood of sale or closure in banks with voluntary audits, consistent with regulator forbearance. Results hold when controlling for audit selection, suggesting regulators perceive both informational and operational benefits to audits. We compare effects across mandatorily and voluntarily audited banks to test whether audit choice supplies an incremental signal of bank type and find limited support. We also examine whether improved reporting via a higher quality loan loss allowance mediates the association between voluntary audits and regulatory sale or closure. Results are consistent with regulators considering higher information quality and operational improvements in intervention decisions. Results should be interesting to stakeholders at risk of loss from community bank sale or closure.