The Effects of Credit Competition on Banks’ Loan Loss Provisions
New York University (NYU) - Department of Accounting, Taxation & Business Law
Stephen G. Ryan
New York University (NYU) - Leonard N. Stern School of Business
George Washington University - Department of Accountancy
November 12, 2014
We exploit variation in interstate branching deregulation across contiguous counties of adjacent states from 1994 to 2005 as a natural experiment to investigate how increased threat of entry affects incumbent banks’ reported loan loss provisions. We argue that these provisions shape the perception of potential entrants into a local loan origination market about incumbents’ loan underwriting quality and thus the desirability of market entry. By loan underwriting quality, we mean banks’ ability to evaluate credit risk to determine which loans to grant as well as the interest rates and other contractual terms of granted loans. We predict that, when deregulation eased restrictions on entry in a state, incumbents had increased incentive to record lower loan loss provisions to appear to have better loan underwriting quality and thus fewer available profitable lending opportunities for potential entrants. Consistent with this prediction, we find that incumbents more subject to entry record lower provisions. We further predict and find and that this behavior is more pronounced in loan origination markets with higher bank concentration, more unsatisfied loan demand, and a higher proportion of commercial loans, which incumbents typically originate based on soft information obtained from relationship lending and local market knowledge.
Number of Pages in PDF File: 50
Keywords: banks, deregulation, interstate branching, credit competition, loan loss provision, loan underwriting quality, natural experiment
JEL Classification: G21, L10, L89, M41
Date posted: December 22, 2012 ; Last revised: November 13, 2014
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