U.S. COMMERCIAL BANK LENDING THROUGH 2008:Q4: NEW EVIDENCE FROM GROSS CREDIT FLOWS

Abstract

I. INTRODUCTION Debate about the behavior of the banking sector has intensified in the popular press, as well as within academia, as the financial crisis continues to gather steam. Many of the questions raised about the behavior of banks during the current crisis rely on net aggregate data on bank lending activity. However, the banking sector is very heterogeneous and aggregate data can be hard to interpret if not combined with observations at the individual bank level, as argued by Chari, Christiano, and Kehoe (2008) and Cohen-Cole et al. (2008). In this paper, we use publicly available balance sheet data for the entire population of commercial banks to construct quarterly gross credit flows for the U.S. banking system during the period 1999:Q1-2008:Q4 and to provide new evidence about the behavior of regulated commercial banks during the financial crisis that began in 2007. Loosely speaking, the weighted sum of positive changes in credit for banks that increased loans is a measure of credit expansion, while the weighted sum of negative changes in credit is a measure of credit contraction. While net flows are a measure of aggregate credit change in the overall economy, gross flows are a measure of how much credit is expanding and contracting or the reallocation of lending across borrowers. Although we use comprehensive balance sheet data to calculate our measures of credit contraction and expansion, we caution that without actual loan origination data or a careful accounting for unused loan commitments, we cannot capture the complete dynamics of credit flows for commercial banks and therefore our results should be interpreted cautiously. Several recent papers have highlighted the importance of considering gross credit flows rather than net lending, in both a domestic context where credit is provided by banks (Dell'Ariccia and Garibaldi 2005; Craig and Haubrich 2006) and firms (Herrera, Kolar, and Minetti 2007) and an international context where credit is provided by countries (Contessi, De Pace, and Francis 2008). In the banking sector, aggregate changes obscure changes in gross lending and the heterogeneous patterns of contraction and expansion within regions, sectors, and groups of banks. Moreover, the elements determining bank-level credit expansion are fundamentally different from those of credit contraction. When banks increase lending, they face informational asymmetries and the costs of information acquisition, searching for new clients, or evaluating new projects. Conversely, when loans are retired because of expiry or nonperformance, different costs occur, which depend on the liquidity of borrowers and on the steps that must be taken to ensure repayment. The different activities underlying expansion and contraction lead to different cyclical properties and volatility measures that we discuss in this paper. (1) We follow two steps in our analysis of gross loan flows. First, we present several findings about gross credit flows in the U.S. banking system between 1999:Q1 and 2008:Q4 and use previous estimates by Dell' Ariccia and Garibaldi (2005) as our main term of comparison; a similar paper by Craig and Haubrich (2006) focuses more on entry and exit, which are relatively less important for the period we study. (2) We then focus on the recent financial crisis and compare behavior during the current recession to the previous four recessions to put current behavior in context. Our results reveal that gross flows are much larger than net flows, so at any phase of the business cycle, significant credit contraction and credit expansion co-exist. We also find significant credit contraction and expansion within banks of similar size, categories of loan--real estate, individual, commercial and industrial (C&I)--and across states. Even with the significant restructuring of the U.S. banking system and attendant reduction in the number of banks between the Dell'Ariccia and Garibaldi (2005) sample (1979-1999) and ours (1999-2008) and an increase in the size of the average bank, we find that a substantial amount of heterogeneity remains. …