Lone (Loan) Wolf Pack Risk
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Abstract
This paper proposes an early-warning bank risk measure based on the syndicate concentration of recent syndicated loans that a bank participates in. At the bank level, higher values of the measure predict greater risks (i.e., loan loss provisions, idiosyncratic return volatility, default probability, and frequency of lawsuits) and lower profitability at least three years ahead, especially for opaque and complex banks. Banks failing the Federal Reserve’s forward-looking stress tests subsequently exhibit a reduction in the syndicate concentration measure. At the aggregate level, higher values of the measure predict both greater financial sector risks and economic slowdowns measured by private-sector investment, business activity, total factor productivity, industrial production, and gross domestic product.
1. Introduction
Bank failures and financial-sector risks can lead to significant economic and social costs (e.g., Bernanke, 1983; Diamond and Dybvig, 1983; Calomiris and Mason, 2003; Ivashina and Scharfstein, 2010a; Jermann and Quadrini, 2012, among others). One of the most important businesses of banks around the world is syndicated lending, with the total value of global syndicated lending amounted to US$3.5 trillion in 2020 according to Refinitiv. A bank’s involvement in syndicated lending may significantly affect its future risks. In this paper, we examine how a bank’s involvement in syndicated lending, as gleaned from its bank-level syndicate concentration, is related to future bank risks and profitability. We show that banklevel syndicate concentration, measured as the loan-size-weighted-average of the inverse of syndicate size based on all recently originated syndicated loans that a bank participates in, serves as a reliable early-warning predictor for future bank risks and bank profitability for at least three years ahead. Moreover, higher levels of aggregate syndicate concentration within the financial system, as more banks start to lend in smaller syndicates with fewer lenders, reliably foreshadow greater financial-sector risks and real-sector economic slowdowns.
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