Can speed kill? The cyclical effect of rapid credit growth: evidence from bank lending behavior in Italy

Abstract

Purpose

This study aims to analyze bank lending behavior before and during the most recent financial crisis. Banks are more willing to grant loans during economic expansion. However, this behavior can result in reduced portfolio asset quality. The analysis tries to facilitate understanding of whether this relationship is always true. A second aim of the study is to highlight whether the impact of credit risk on bank lending behavior during a financial crisis is greater for banks that grew faster during the pre-crisis period than for other banks.

Design/methodology/approach

The analysis is based on a sample of banks in Italy, an example of a country undergoing a credit crunch without a lending bubble burst. The methodology is based on a panel regression and author uses different models to test his hypothesis: an ordinary least squares, a fixed effect, a least absolute regression and a Generalized Method of Momentum (GMM). This allows to mitigate some of the endogeneity problems.

Findings

The essay shows that effectively, most of the banks that grew faster during a pre-crisis period show a higher growth of non-performing loans and a greater reduction in lending activity during a financial crisis. However, 34 per cent of banks that grew faster during a pre-crisis period have a low growth of non-performing loans in the subsequent years. Finally, the results suggest that credit risk negatively affects bank lending behavior, but a higher impact relative to fast banks with respect to other banks cannot be emphasized.

Practical implications

Findings have some policy implications. First, given the adverse effect of the increase of non-performing loans (NPLs) on the bank’s lending activity and on the broad economy in general, there is merit to strengthen supervision to prevent a further increase and accumulation of NPLs in the bank’s credit portfolio. In addition, the supervisors could require that banks take always high credit standard when extend credit, both during positive economic cycle and during period of contraction. The using of higher credit standard could be helpful in the reduction of the pro-cyclicality of bank’s lending behavior and credit risk. Furthermore, the fact that high level of NPLs continues to impact on the bank’s lending activity and that this activity is very important for the economic recovery underlines that banks should clean-up their credit portfolios as soon as possible.

Originality/value

This paper contributes to the literature in various ways. The study analyzes the cyclical effect of credit growth, i.e. banks increase their bank lending behavior during good times, which leads to an increase in bad loans and a high credit risk in their portfolio. These cyclical effects are not knowingly studied together, but the literature usually analyzes the single steps of the cycle. Second, studying listed and unlisted banks allows to have a more representative sample and to analyze better the real bank lending activity considering both commercial than cooperative banks.

Citation

Cucinelli, D. (2016), "Can speed kill? The cyclical effect of rapid credit growth: evidence from bank lending behavior in Italy", Journal of Risk Finance, Vol. 17 No. 5, pp. 562-584. https://doi.org/10.1108/JRF-03-2016-0035