Real Activity Forecasts Using Loan Portfolio Information

Abstract

To extend and monitor loans, banks collect detailed and proprietary information about the financial prospects of their customers, many of whom are local businesses and households. Therefore, banks’ loan portfolios contain potentially useful information about local economic conditions. We investigate the association between information in loan portfolios and local economic conditions. Using a sample of U.S. commercial banks from 1990:Q1 to 2013:Q4, we document that information in loan portfolios aggregated to the state level is associated with current and future changes in statewide economic conditions. Furthermore, the provision for loan and lease losses contains information incremental to leading indicators of state‐level economic activity and recessions. Loan portfolio information also helps to improve predictions of economic conditions at more granular levels, such as at the commuting zone level. We discuss the relevance of these findings for economic analysis and forecasting, and the relation of our study to prior work on the informativeness of accounting information about the macroeconomy.

Current Expected Credit Losses (CECL) Standard and Banks' Information Production

“…Qian et al [2015] find that better information production by loan officers in Chinese banks improves the forecasting power of interest rates on future outcomes. Khan and Ozel [2016] find that banks' loan portfolios contain useful information about local economic conditions because banks collect detailed and proprietary information about the financial prospects of their customers. Lisowsky et al [2017] show that banks collected less information from construction firms in the run-up to the financial crisis, which is closely associated with the lower lending standards before the housing crisis.…”

“…16 Next, we examine whether CECL adopting banks' LLPs contain more information about local economic conditions where they operate. Khan and Ozel [2016] find that banks' loan portfolios contain useful information about local economic conditions because banks collect detailed and proprietary information about the financial prospects of their customers. If banks' LLPs reflect changes in local economic conditions better due to better information quality, we expect the negative relationship between current LLPs and changes in future local economic indicators to become stronger after CECL adoption.…”

“…If banks' LLPs reflect changes in local economic conditions better due to better information quality, we expect the negative relationship between current LLPs and changes in future local economic indicators to become stronger after CECL adoption. We proxy local economic conditions using the coincident index, a comprehensive measure of economic activity at the state level [Khan and Ozel, 2016]. 17 We formally test this hypothesis using the following model:…”

“…In this paper, we examine whether CECL adoption affects banks' information production and investigate the potential channels through which these effects might arise. 2 Prior studies show that banks' information sets affect their reporting choices and operating decisions [Leland and Pyle, 1977, Diamond, 1984, Qian et al, 2015, Khan and Ozel, 2016, Lisowsky et al, 2017, Howes and Weitzner, 2021. Thus, understanding the impact of CECL adoption on banks' information production processes provides insights into how and why the CECL approach as an accounting standard could affect banks' real decision-making (e.g., lending).…”

Mimicking Regulatory Peers

“…6 In addition, banks may not want to have lower levels of capital than their peer group averages due to concerns about depositors' assessments of their stability. Second, the UBPR peer information can convey important information to banks, such as relevant industry-and market-wide information regarding the state of the economy (Khan and Ozel, 2016), leading them to rely on peer information more relative to their own private information. Banks can also learn about the optimal capital ratio to maintain given the behavior of their peers (Bernard et al, 2021;Leary and Roberts, 2014).…”