Off-balance sheet activities and community bank performance

Abstract

Purpose

The purpose of this paper is to examine loan commitments and lending patterns of community banks. The authors also test for shifts in these relationships in the period unwinding the subprime crisis.

Design/methodology/approach

Standard panel fixed-effect models as well as hierarchical (mixed) regression models are estimated given that banks operating in a specific geographic market may vary systematically with differences in firm-level characteristics. Hierarchical (mixed) regression models can control for within-counties and within-banks similarities. The authors also employ pooled estimations with clustered standard errors at the bank level as robustness check.

Findings

The empirical results show that the use of loan commitments is generally associated with moderate increase in profitability and higher insolvency risk. However, during the recent financial crisis, the use of loan commitments becomes safer. The use of loan commitments is more risky for community banks that concentrate more on loans that focus on real estate, while it is safer for community banks with higher equity. In regards to the performance of community banks’ balance sheet loan activities, a more concentrated loan portfolio results in lower return and higher insolvency risks. High loan growth generates higher return and higher risks.

Originality/value

Prior to the 2008 credit meltdown, community banks significantly increased their issuance of off-balance sheet loan commitments. While the ratio of loan commitments to total loans has come down in recent years it continues to exceed the levels reached in the 1990s. This evolution has, however resulted in little research regarding its implications on community bank profitability and risk.

Citation

Kashian, R.D. and Tao, R. (2014), "Off-balance sheet activities and community bank performance", Journal of Economic Studies, Vol. 41 No. 6, pp. 789-807. https://doi.org/10.1108/JES-01-2013-0010