Loan Portfolio Composition And Management Control Of Bank Risk: An Empirical Investigation

Abstract

The extent of managerial control over loan default risk is a significant policy issue for commercial banks and the public agencies which regulate them.  The responsibility of bank management and the rationale for government regulation and deposit insurance rest in large measure on the fundamental issue of whether loan loss variances (over time and across banks) ensue from managerial decisions or macroeconomic conditions.  Our time series models of large banks show systematic, bank dependent loss rates over time, the signs of the coefficients confirm a risk reinforcing rather than a risk adjusting management culture.  Our cross sectional regressions reveal significant relationships between individual and group (all sample bank) loan losses for commercial and c consumer types of loans, indicating that significant unpredictable macroeconomic forces exist.  Thus, we identify risks arising from macroeconomic conditions appropriate for government insurance and risks ensuing from managerial decisions appropriate free market discipline.