Housing Price Risks and Lending Behavior of Banks before and after the 2008 Financial Crisis

Abstract

As a large volatility in asset values can negatively affect collateral values and increase the likelihood of defaults by loan borrowers, facing high price risks in real-estate markets, banks need to lower risk exposures and reduce loans. However, our analysis of US commercial banks shows that banks in Metropolitan Statistical Areas (MSAs) with higher housing price risks make more real estate loans, especially to construction loans before the 2008 financial crisis. After the crisis, banks have changed such lending behaviors and made less loans. While increasing their loans in markets with high risks, banks do not prepare for more reserves for loan losses in the pre-crisis period. Our results suggest that banks with higher housing price risks have taken excessive risks before the 2008 crisis.