Two Essays on Understanding Commercial Banks

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Small community banks are different from large, national banks in both the way they operate and the values they provide to their communities. My first essay is about how small and large bank managers have different motives behind managing their loan loss allowances and loan loss provisions. Bank managers have the ability to exercise their discretion in determining loan loss allowances and loan loss provisions, which directly increase or decrease reported earnings. The existing literature suggests different managerial motives behind adjusting loan loss allowances (LLAs) and loan loss provisions (LLPs) upward during good financial and economic periods. Using a digital analysis method based on Benford’s law, I analyze rounding patterns in LLAs in good and bad times. I partition my bank samples based on net income, profitability, bank size, regulatory level, and whether the banks are private or public. My results are consistent with previous studies which argue that managers of small banks make discretionary adjustments to LLAs and LLPs for non-opportunistic motives including signaling, reducing pro-cyclicality, and improving efficiency. My second essay is about how banking relationship, a community bank feature, may help overcome lending outcome discrepancies between different demographic groups of borrowers. First-time minority borrowers tend to receive less desirable outcomes than first-time white borrowers. This is partly due to having less credit risk information for lenders to gather. By using soft information about new borrowers, relationship lenders can draw insights into the borrowers’ creditworthiness without the need of an existing bank-borrower relationship. Because of that, relationship lenders can benefit new minority borrowers by alleviating imperfect information and lending discrimination problems. In this study, I show that borrowing from a relationship lender reduces lending outcome discrepancies between new minority borrowers and new white borrowers. Besides loan acceptance rates, discrepancies in borrower’s perceptions, which include satisfaction level and the likelihoods of facing borrowing challenges, are also reduced. These results suggest that borrower’s soft information is an important part of relationship lenders’ decision making process.

Embargo status: Restricted until 06/2028. To request the author grant access, click on the PDF link to the left.

Commercial Banks, Loan Loss Allowance, Benford’s Law, Imperfect Information, Soft Information, Relationship Lending, Bank Regulation, Lending Discrimination