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The relationship between loan classifications and losses : the effects of a changing economy

Author

Listed:
  • Catharine Lemieux
  • Kenneth Spong

Abstract

The agriculture and energy sectors suffered dramatic declines during the 1980s in the Tenth Federal Reserve District. Bank asset quality also declined during this time period, particularly for farm banks. Using information on loan classifications and charge-offs, this study traces classified loans over time to determine their subsequent performance. ; This study found that examiners were able to identify a majority of the problem credits prior to charge-off. Additionally, examiners were able to distinguish the relative riskiness of problem credits. Economic conditions were found to have a significant impact on the disposition of substandard credits during the 1980s. The results of this study, when compared to other work done over the 1960s and 1970s, illustrate how economic cycles can affect both the volume of classified loans at banks and the loss rates on these loans. This study implies that bankers and supervisors should take a long-run view in judging the adequacy of capital and loan loss reserves and plan in advance for periods of economic stress.

Suggested Citation

  • Catharine Lemieux & Kenneth Spong, 1992. "The relationship between loan classifications and losses : the effects of a changing economy," Financial Industry Perspectives, Federal Reserve Bank of Kansas City, issue Dec, pages 1-14.
    • Handle: RePEc:fip:fedkfi:y:1992:i:dec:p:1-14
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