Delays in Banks’ Loan Loss Provisioning and Economic Downturns: Evidence from the U.S. Housing Market

Abstract

I study whether banks’ loan loss provisioning contributed to economic downturns by examining the U.S. housing market. Specifically, I examine the influence of delayed loan loss recognition (DLR) on bank lending and risk-taking in the U.S. mortgage market and the aggregate effects of DLR on house prices and household consumption during the Great Recession. I first examine the effects of DLR on individual banks’ behavior. Then I construct ZIP code-level exposure to banks’ DLR to examine the aggregate effects of banks’ DLR on the housing market. I find high DLR banks reduced mortgage supply, leading high exposure ZIP codes to experience larger decreases in mortgage supply during the crisis. Mortgages from high DLR banks were also more likely to become distressed, leading to more foreclosures and short sales in high exposure ZIP codes during the crisis. Consequently, banks’ DLR negatively affected house prices during the crisis, implying a significant decrease in household consumption. These findings suggest banks’ loan loss provisioning affected loan supply and risk-taking, exacerbating the economic downturn via the household channel.