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Why Does Fast Loan Growth Predict Poor Performance for Banks?

Listed author(s):
  • Rüdiger Fahlenbrach
  • Robert Prilmeier
  • René M. Stulz

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.

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File URL: http://www.nber.org/papers/w22089.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 22089.

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Date of creation: Mar 2016
Handle: RePEc:nbr:nberwo:22089
Note: CF
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