Bank Information Production Over the Business Cycle

Abstract

The information banks have about borrowers drives their lending decisions and macroeconomic outcomes, but this information is inherently difficult to analyze because it is private. We construct a novel measure of bank information quality from confidential regulatory data that include banks’ private loan-level risk assessments for US corporate loans. We show that our measure of information quality improves as local economic conditions deteriorate, particularly among loans with greater information sensitivity. To alleviate endogeneity concerns, we also use unexpected snowfall as an exogenous shock to local economic conditions. Taken together, our results provide support for theories in which economic conditions and security design decisions drive information production in credit markets. Our findings also suggest that policies designed to stimulate macroeconomic activity through the banking sector may be less effective in recessions.