Bank expectations and prudential outcomes

We study bank expectations using a unique and rich data set derived from regulatory returns. The data covers key bank-level variables, including profitability, capital, and loan impairments. We find that banks tend to be optimistic, expecting higher returns, higher capital ratios and fewer impairments than are subsequently realised. However, there is substantial variation in forecasting performance across banks, and banks with better quality governance and management tend to also have smaller forecast errors. We go on to examine the relationship between forecast performance and bank outcomes, finding that forecast errors are associated with greater prudential risk, even after controlling for bank and time fixed effects. Importantly, forecast errors have an asymmetric effect on bank outcomes – errors of optimism drive our findings. We find that forecast errors are also associated with lending – banks that have higher errors tend to have significantly lower subsequent loan growth.