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The Implications of Credit Risk Modeling for Banks’ Loan Loss Provisions and Loan-Origination Procyclicality

63 Pages Posted: 2 Jan 2012 Last revised: 5 Aug 2017

Gauri Bhat

Southern Methodist University (SMU)

Stephen G. Ryan

New York University (NYU) - Leonard N. Stern School of Business

Dushyantkumar Vyas

University of Toronto - Rotman School of Management; University of Toronto at Mississauga

Date Written: August 4, 2017

Abstract

Economic policymakers express concern that procyclical lending by banks imperils financial stability. Prior research finds that banks that record timelier loan loss provisions originate more loans during downturns, consistent with loan-loss-provision timeliness mitigating loan-origination procyclicality. Motivated by this concern and research, we examine whether banks’ credit risk modeling disciplines both their loan loss provisions and loan origination. We identify two forms of credit risk modeling from banks’ financial report disclosures: statistical modeling of the drivers of past loan losses and stress testing of future loan losses to adverse scenarios. We show that banks’ credit-risk-modeling disclosures are positively associated with their loan-loss-provision timeliness, with the ability of their provisions to predict future loan charge-offs, and with their loan origination during downturns. We further show that these associations vary in predictable ways across the two forms of credit risk modeling when we distinguish homogeneous from heterogeneous loans and stable periods from downturns.

Keywords: Credit Risk Modeling, Loan Loss Provisions, Timeliness, Procyclicality, Financial Crisis, Disclosure

JEL Classification: G21, G28, M41, M48

Suggested Citation

Bhat, Gauri and Ryan, Stephen G. and Vyas, Dushyantkumar, The Implications of Credit Risk Modeling for Banks’ Loan Loss Provisions and Loan-Origination Procyclicality (August 4, 2017). Available at SSRN: https://ssrn.com/abstract=1978409 or http://dx.doi.org/10.2139/ssrn.1978409

Gauri Bhat

Southern Methodist University (SMU) ( email )

6212 Bishop Blvd.
Dallas, TX 75275
United States
214-7682964 (Phone)

Stephen G. Ryan (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street, Suite 10-73
New York, NY 10012-1118
United States
212-998-0020 (Phone)

Dushyantkumar Vyas

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

University of Toronto at Mississauga ( email )

3359 Mississauga Rd N.
Mississauga, Ontario L5L 1C6
Canada

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