Loan Growth and Loan Quality: Some Preliminary Evidence from Texas Banks

Following the failures of depository institutions in the 1980s, many analysts concluded that the rapid growth of lending activity and the deterioration of loan quality were related. Evidence suggests that additional lending to new or existing customers beyond what might be normal at a given stage of the business cycle lowers loan quality after a 3-year lag. This relationship, based on evidence from Texas banks, was especially strong at banks with below-average capitalization. One method of increasing lending while maintaining loan quality was through the purchase of failed banks with the assistance of the Federal Deposit Insurance Corp. (FDIC). These purchases increased lending only for the acquiring banks and did not reflect an increase in total lending for the banking industry. It is possible that FDIC resolution procedures have discouraged the acquisition of weak but still solvent banks by stronger banks and are thereby slowing the rate of needed consolidation in the banking industry.