Abstract
Credit quality is an important constituent of a bank’s asset portfolio. Asset quality and inadequate capital reserves were two significant triggers of the Global Financial Crisis (GFC) in 2009. Since then, there has been substantial regulatory and internal risk management changes within the US banking industry. There are no previous specific studies on smaller US banks. This study reviews the empirical literature on the topic of asset quality, bank profitability and market value along with statistics specific to the US banking industry. The impact on profitability is assessed through the return on equity ratio (ROE) and the impact on market value is assessed through the market to book ratio (MTBR). Along with the non-performing loan ratio (NPL), three other CAMEL ratios were also used as independent variables: capital adequacy (TRWCA), liquidity (LIQ) and management efficiency (MAN) to assess their impact on profitability and market value. Panel data has been collected for fifteen smaller US banks and the Generalised Method of Moments (GMM) of estimation is used robustly to estimate the effects of CAMEL ratios on bank profitability and market value. The link between NPL and other ratios on bank profitability and market value in smaller US banks has been assessed. The importance of the NPL ratio for bank profitability and market value is once again confirmed.
Highlights
The US has approximately 600 publicly listed banks of which 550 are on the NASDAQ stock exchange and the remaining 50 on the NYSE
The aim of this research is to ascertain the impact of bank specific variables, those related to non-performing loans on bank performance (ROE) and market value (MTBR) in smaller US banks, an area which has not so far been studied
This research has provided a critical summary of prior literature related to asset quality and bank profitability along with an overview of the data collection and research methodology and design used
Summary
The US has approximately 600 publicly listed banks of which 550 are on the NASDAQ stock exchange and the remaining 50 on the NYSE. Within those numbers, there are 5-10 large banks that dominate the US financial services market. One of the most significant outcomes of the GFC was new banking regulations (Dodd-Frank Wall Street Reform and Consumer Protection Act) enacted into law in 2010 by the United States government and regulated by the Federal Reserve along with the Basel II and III Accord, aimed at increasing the asset quality of bank loan portfolios and capital adequacy requirements to ensure bank solvency from adverse future events. Prior to the GFC, many banks had increased the risk profile of their loan portfolios and as a result suffered large losses during the GFC and for a couple years afterwards
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