Academic journal article Contemporary Economic Policy

Trough to Peak: A Note on Risk-Taking in the Pacific Northwest's Banking Sector, 2001-2007

Academic journal article Contemporary Economic Policy

Trough to Peak: A Note on Risk-Taking in the Pacific Northwest's Banking Sector, 2001-2007

Article excerpt

I. INTRODUCTION

The U.S. recession that started in December 2007 ushered in the worst banking crisis since the 1930s. However, because the focus has been on "too-big-to-fail" (TBTF) financial institutions (e.g., Adrian and Shin 2008), much less is understood about the risk-taking behavior of smaller banks over the pre-crisis expansion. In particular, less is known concerning the characteristics associated with more aggressive risk-taking among smaller banks. From a policy perspective this is problematic since, at the time of this writing, the United States is experiencing a surge in the number of troubled, non-TBTF banks which act as an important source of small business lending (see Cole, Goldberg, and White 2004).

To better understand the pre-crisis risk-taking of smaller banks, this paper examines a cohort of 157 banks based in the U.S. Pacific Northwest (PNW) over the 2001-2007 expansion, as dated by the National Bureau of Economic Research (NBER). The PNW includes Idaho, Montana, Oregon, and Washington. With the disclosure of riskweighted assets (RWAs) by individual banks, researchers have a window into the risk-taking behavior of banks by looking at changes in the allocation of assets across four statutory risk categories. The emphasis here will be on the behavior of the highest-risk category of assets from fourth quarter 2001 (trough of the 2001 recession) to fourth quarter 2007 (peak of the 2001-2007 expansion). (1)

The PNW is an excellent case study for two reasons. First, compared to the United States as a whole, the PNW experienced a rapid growth in construction activity, which was a central driver of the pre-crisis expansion. As a proxy for all construction activity, Table 1 shows the average annual growth in non-farm and construction employment from 2001 to 2007 for the PNW and United States. The PNW's construction employment grew at 4.8% compared to 2.8% for the United States. The PNW's rapid growth occurred in both metropolitan statistical areas (MSAs; 4.5%) and non-MSAs (5.7%). Growth in the non-MSAs of Idaho and Montana were particularly robust. Second, the PNW is populated by a large number of small banks headquartered in the region, particularly in Montana and Washington. The median asset size of the 157 banks in this study was just over $100 million at the start of the 2001-2007 expansion.

TABLE 1 Average Annual Employment Growth in Non-Farm and Construction
Employment, 2001-2007

Location    Total       Total      Total        Total
          Non-Farm   Non-Farm,   Non-Farm,  Construction
            (%)       MSA (%)     Non-MSA       (%)
                                  (%)

United         1.4        1.4        1.1           2.8
States

All four       2.0        2.0        2.0           4.8
PNW
states

Location  Construction,  Construction,
             MSA (%)      Non-MSA (%)

United              2.8            3.0
States

All four            4.5            5.7
PNW
states

Source: Bureau of Economic Analysis and author's calculations.

The paper is organized as follows: Section II provides a brief background on bank lending leading up to the crisis; Section III presents a conceptual framework for lending behavior; Section IV discusses the study's data; Section V presents the regression results linking risk-taking to bank-specific characteristics; and Section VI discusses the policy issues flowing from Section V.

II. PRE-CRISIS BACKGROUND

The number of failed banks insured by the Federal Deposit Insurance Corporation (FDIC) increased from 3 in 2007 to 140 in 2009, while the number of problem institutions increased from 76 to 702 (FDIC 2009). The median asset size of all 205 failed banks from 2007 through first quarter 2010 is only $280 million. Although the FDIC does not report the individual details of problem institutions, the data on failed banks suggest that the majority of problem banks have less than $1 billion in assets. Although FDIC-insured banks with $1 billion or less in assets only account for about 10% of total assets, their large numbers mean they will continue to represent a post-crisis regulatory challenge. …

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