Mimicking Regulatory Peers

ABSTRACT Bank regulators use peer information for bank evaluations and publicly disclose this information. This study investigates whether the regulatory use and disclosure of peer information induce herding behavior in banks' regulatory capital ratios. I examine this question using a 2004 peer group reform that introduced class‐of peer groups for newly chartered banks, grouping them exclusively with their cohorts, while established banks continued to be compared with similar‐sized banks. The results show that, post‐reform, banks exhibit heightened herding behavior in their regulatory capital ratios. Depending on their relative capital position, banks either become more sensitive to changes in the peer group average or converge toward it. Additionally, I find that under‐capitalized banks adjust loan portfolios to manage their capital ratios, and this gap‐closing behavior is associated with worse subsequent loan quality, higher bank failure rates during the financial crisis, and, at the bank holding company level, larger systemic‐risk contributions. These findings highlight significant implications of regulatory disclosure for bank behavior and stability.