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Why Does Fast Loan Growth Predict Poor Performance for Banks?

Author

Listed:
  • Rüdiger Fahlenbrach

    (Ecole Polytechnique Fédérale de Lausanne; Ecole Polytechnique Fédérale de Lausanne - Swiss Finance Institute)

  • Robert Prilmeier

    (Tulane University - A.B. Freeman School of Business)

  • René M. Stulz

    (Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI))

Abstract

From 1973 to 2014, the common stock of U.S. banks with loan growth in the top quartile of banks over a three-year period significantly underperforms the common stock of banks with loan growth in the bottom quartile over the next three years. The benchmark-adjusted cumulative difference in performance over three years exceeds twelve percentage points. The high growth banks also have significantly higher crash risk over the three-year period. This poor performance is explained by fast loan growth as asset growth separate from loan growth is not followed by poor performance. These banks reserve less for loan losses when their loans grow quickly than other banks. Subsequently, they have a lower return on assets and increase their loan loss reserves. The poorer performance of the fast growing banks is not explained by merger activity and loan growth through mergers is not accompanied by the same poor loan performance. The evidence is consistent with fast-growing banks, analysts, and investors failing to properly appreciate the extent to which the fast loan growth results from making riskier loans and failing to charge for these risks correctly.

Suggested Citation

  • Rüdiger Fahlenbrach & Robert Prilmeier & René M. Stulz, 2016. "Why Does Fast Loan Growth Predict Poor Performance for Banks?," Swiss Finance Institute Research Paper Series 16-24, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1624
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    Keywords

    Credit boom; loan growth; bank performance; bank returns; loan loss provisions;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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