Why Does Fast Loan Growth Predict Poor Performance for Banks?

58 Pages Posted: 9 Mar 2016

See all articles by Rüdiger Fahlenbrach

Rüdiger Fahlenbrach

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)

Multiple version iconThere are 2 versions of this paper

Date Written: March 8, 2016

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.

Keywords: Credit boom, loan growth, bank performance, bank returns, loan loss provisions

JEL Classification: G01, G12, G21

Suggested Citation

Fahlenbrach, Rüdiger and Prilmeier, Robert and Stulz, Rene M., Why Does Fast Loan Growth Predict Poor Performance for Banks? (March 8, 2016). Charles A. Dice Center Working Paper No. 2016-7; Fisher College of Business Working Paper No. 2016-03-07; Swiss Finance Institute Research Paper No. 16-24. Available at SSRN: https://ssrn.com/abstract=2744687 or http://dx.doi.org/10.2139/ssrn.2744687

Rüdiger Fahlenbrach

Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny
Extranef 211
1015 Lausanne, CH-1015
Switzerland
++41-21-693-0098 (Phone)
++41-21-693-3010 (Fax)

HOME PAGE: http://sfi.epfl.ch/fahlenbrach.html

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Robert Prilmeier

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

7 McAlister Drive
New Orleans, LA 70118
United States

Rene M. Stulz (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

HOME PAGE: http://www.cob.ohio-state.edu/fin/faculty/stulz

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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