Banking Sector Expectations and Financial Stability

52 Pages Posted: 28 Sep 2021 Last revised: 5 Oct 2023

Date Written: January 1, 2022


We analyze banks' expectations embedded in loan loss provisions and document evidence of overreaction for the US banking sector. Using diagnostic-expectations general equilibrium setting, we establish that overreaction in provisions accentuates the procyclicality of lending rate and credit growth. Crucially, our results suggest that for the cyclically-adjusted provisioning rules (IFRS 9/CECL) to have the desired effect on financial stability, the extent of cyclical adjustment may need to be strengthened in proportion to the degree of overreaction in expectations.

Keywords: verreaction, Banks' Expectations, Loan Loss Provisions, Financial Stability

JEL Classification: E44, G21, G41, M41, M48

Suggested Citation

Parija, Arpit Kumar and Mathur, Vipul, Banking Sector Expectations and Financial Stability (January 1, 2022). Available at SSRN: or

Arpit Kumar Parija (Contact Author)

IIM Calcutta ( email )


Vipul Mathur

IIM Calcutta ( email )

New Academic Building, IIM Calcutta
Joka, Diamond Harbour Road
Calcutta, West Bengal 700104

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