Bank monitoring, profit efficiency and the commercial lending business model

We build a bank-specific, fixed-effects regression model to develop proxies for a bank's monitoring effort. Our results show that banks that devote more resources to monitoring (based on these proxies) are more profit efficient and the effect is large. A very important theoretical literature in finance suggests that monitoring is value enhancing; we provide empirical evidence consistent with the theory. This research thus establishes an important link between the large literature on bank monitoring and the equally large literature on profit efficiency. Monitoring is a key technology in the commercial lending business model (e.g. Mester, Nakamura, & Renault, 2007). Thus, these results point to considerable strengths in the dominant business model used in the banking industry.