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This chapter empirically investigates how banks evaluate the creditworthiness of small- and medium-sized enterprises (SMEs). Following SME loan underwriting literature that distinguishes among different lending technologies, we test whether the typical SME bank loan is underwritten primarily based on just a single technology. We find that although financial statement lending is the most commonly used and serves as a kind of basic technology, it tends not to be used to the exclusion of other technologies. These findings imply that, at least in Japan, SME lending practice may be inconsistent with academic research on how banks underwrite loans elsewhere.

Purpose – This chapter investigates the influence of bank loan underwriting practices on loan losses and identifies potential determinants of lending practices for five categories of loans: business, consumer, commercial real estate, home equity, and construction and land development loans.

Methodology/approach – Using data on the riskiness of lending practices obtained from the U.S. Federal Deposit Insurance Corporation (FDIC) bank examiner surveys from January 1996 to March 2009, I fit a two-step treatment effects model to measure the effects of underwriting practices on loan losses, controlling for the potential endogeneity of lending practices.

Findings – In the selection step, I find that for business loans, the likelihood that bank management will adopt low-risk lending practices increases with bank financial performance and management quality hierarchical complexity and decreases with market competition. Results for the selection of lending practices for consumer loans and three categories of real estate loans are similar to those found for business loans but show weaker statistical relationships to all explanatory variables. In the loss determination step, I find that lower (higher) risk underwriting practices are generally associated with lower (higher) gross loan charge-offs (as percentage of gross loans and leases) for five categories of loans: business, consumer, commercial real estate, home equity, and construction and land development loans.

Originality/value of chapter – This is the first study to model the determinants of loan underwriting practices with the practices being characterized in terms of their risk to the bank. In addition, this is the first study to consider the effects of the riskiness of lending practices on loan losses, controlling for the endogeneity of practices.

Studies of Depression-era financial remediation have generally focused on federal deposit insurance and the provision of equity to banks by the Reconstruction Finance Corporation (RFC). This paper broadens the concept of financial remediation to include other programs – RFC lending, federal guarantees of farm and home mortgages, and the elimination of interest on demand deposits – and other intermediaries – savings and loans, mutual savings banks, and life insurance companies. The benefits of remediation or the amounts potentially at risk to the government in these programs are calculated annually and allocated to the various intermediaries. The slow remediation of real estate loans (two-thirds of these intermediaries' loans) needs further study with respect to the slow economic recovery. The paper compares Depression-era remediation with efforts during the 2008–2009 crisis. Today's remediation contrasts with the 1930s in its speed, magnitude relative to GDP or private sector nonfinancial debt, the share of remediation going to nonbanks, and emphasis on securities markets.

This chapter reports on the “CEO’s-eye-view” of the 1990 financial crisis at Citibank using unique data from CEO John Reed’s private archives. This qualitative analysis sheds light on questions that have perennially plagued executives and intrigued scholars: How do organizations change routines in order to overcome inertia in the face of radical change in the environment? And, specifically, what is the role of the CEO in this process? Inertial behavior in such circumstances has been attributed to ingrained routines that are based on cognitive and motivational truces. Routines are performed because organizational participants find them to cohere to a particular cognitive frame about what should be done (the cognitive dimension) and to resolve conflicts about what gets rewarded or sanctioned (the motivational dimension). The notion of a “truce” explains how routines are “routinely” activated. Routines are inertial because the dissolution of the truce would be inconsistent with frames held by organizational participants and fraught with the risk of unleashing unmanageable conflict among interests in the organization. Thus, the challenge for the CEO in making intended change is both to break the existing truce and to remake a new one. In this study, I uncover how the existing organizational truce led to the crisis at Citibank, why Reed’s initial attempts to respond failed, and how he ultimately found ways to break out of the old truce and establish new routines that helped the bank survive. These findings offer insight into the cognitive and motivational microfoundations of macro theories about organizational response to radical change.

Both neoclassical and Keynesian economists have widely favored the use of equilibrium models to understand economic activity, but dramatic periods of change such as the current global economic downturn are poorly understood by assuming equilibrium. The economist Joseph Schumpeter tried to inject dynamism and disequilibrium into economic models by arguing for the role of entrepreneurs in creating microeconomic change, and for examining long-term macroeconomic change as represented in business cycles. No economist, including Schumpeter, has ever connected these two approaches to change and these approaches are not typically used as alternative and complementary ways of viewing transformation over time. We suggest that these theories can be connected in a “mesoeconomic” institutional analysis rooted in economic sociology; we demonstrate this connection by examining the US commercial building industry. This industry has changed in qualitatively distinct ways over the past two centuries in what we call market orders, economic orders sometimes lasting for decades or more. In each market order, entrepreneurs of different sorts are able to flourish and push forward institutional changes that result in long-term economic shifts. Credit and finance have been pivotal influences in each market order, a factor supporting Schumpeter's focus on entrepreneurial action and speculation and one not largely discussed today. We view the recent disruption of financial markets as a signal of the destruction of a reigning market order.

At the time they occurred, the savings and loan insolvencies were considered the worst financial crisis since the Great Depression. Contrary to what was then believed, and in sharp contrast with 2007–2009, they in fact had little macroeconomic significance. Savings and Loan (S&L) remediation cost between 2 percent and 3 percent of Gross Domestic Product (GDP), whereas the Troubled Asset Relief Program (TARP) and the conservatorships of Fannie and Freddie actually made money for the US Treasury. But the direct cost of government remediation is largely irrelevant in judging macro significance. What matters is the cumulative output loss associated with and plausibly caused by failing financial institutions. I estimate output losses for 1981–1984, 1991–1998, and 2007–2026 (the latter utilizing forecasts and projections along with actual data through 2015) and, for a final comparison, 1929–1941. The losses associated with 2007–2009 have been truly disastrous – in the same order of magnitude as the Great Depression. The S&L failures were, in contrast, inconsequential. Macroeconomists and policy makers should reserve the word crisis for financial disturbances that threaten substantial damage to the real economy, and continue efforts to identify in advance financial institutions which are systemically important (SIFI), and those which are not.

Systemic banking crises can have devastating effects on the economies of developing or industrialized countries. This paper reviews the factors that weaken banking systems and make them more susceptible to crises. It is the first of two papers examining root causes of banking crises and time-consistent policies for resolving them.