The Profit-Credit Cycle

68 Pages Posted: 13 Dec 2018 Last revised: 6 Dec 2019

See all articles by Björn Richter

Björn Richter

Universitat Pompeu Fabra; Barcelona Graduate School of Economics (Barcelona GSE)

Kaspar Zimmermann

Leibniz Institute for Financial Research SAFE

Date Written: December 2, 2019

Abstract

Bank profitability leads the credit cycle. An increase in return on equity of the banking sector predicts rising credit-to-GDP ratios in a panel of 17 advanced economies spanning the years 1870 to 2015. However, increases in profitability also predict elevated crisis likelihood a few years later. These results are consistent with behavioral credit cycle models in which banks extrapolate past loan losses to expected future credit outcomes: following a sequence of positive news bankers become increasingly optimistic, expand credit, but they are systematically disappointed by future realizations. Using recent US data, we show that survey-based measures of optimism and profitability expectations are indeed tightly linked to past profitability, forecast credit growth, and display predictable forecast errors.

Keywords: Credit cycles, bank profitability, financial crises.

JEL Classification: E32, E44, G01, G21

Suggested Citation

Richter, Björn and Zimmermann, Kaspar, The Profit-Credit Cycle (December 2, 2019). Available at SSRN: https://ssrn.com/abstract=3292166 or http://dx.doi.org/10.2139/ssrn.3292166

Björn Richter (Contact Author)

Universitat Pompeu Fabra ( email )

Ramon Trias Fargas, 25-27
Barcelona, E-08005
Spain

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

Kaspar Zimmermann

Leibniz Institute for Financial Research SAFE ( email )

Frankfurt am Main
Germany

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