Abstract:
We propose that individual banks' reported loan losses and provisions for future loan losses
are lower, all else equal (including their own financial statements), when the banking industry
is weaker. We further hypothesize that this option of underreporting charge-offs and
provisions provides banks with incentives, when the banking industry is weaker, to cluster
more, or to seek "safety in similarity."
We provide evidence that large, individual U.S. banks indeed tend to report both lower
charge-offs and lower provisions for loan losses, after controlling for their other determinants,
when the banking industry is weaker. We also show that banks tend to be more clustered, or
similar, when the industry is weaker. In addition, individual banks change their risk-taking to
make it more similar to that of banking industry averages, and change it faster, when the
industry is weaker. At the same time, in contrast to banks, we show that non-bank financial
corporations show virtually no tendency to cluster more as their part of the financial sector
weakens.