Determinants of bank loan charge-
oﬀrates: evidence from the USA
Department of Economics, Illinois Wesleyan University, Bloomington, Illinois, USA
Purpose –Using data on 5,176 commercial banks in the USA for the period 1999Q1-2016Q3, the present
study aimsto examine the underlying determinants of loan charge-offrates.
Design/methodology/approach –The study usespanel data ﬁxed-effects estimation methodology.
Findings –Greater regulatorycapital, more diversiﬁcation, higher proﬁts and cost efﬁciencyreduce charge-
off rates. On the contrary, a higher share of loans in banksasset portfolio and a higher share of real estate
loans have a detrimental impact on loan performance. Moreover, strong US macroeconomic fundamentals
reduce loancharge-offs. Finally, real estate loancharge-offs are most sensitive to balancesheet conditions.
Practical Implications –Consistent with Basel-III regulation, the resultsunderscore the importance of
banks to remain well capitalized. Greater tier-1 capital refrains banks from riskylending practices, thereby
improving their loan performance.It is also important that banks maintain a diversiﬁed income streamand
earn higher proﬁtability.Finally, managerial inefﬁciencies leading to higher non-interestexpense needs to be
reduced toimprove loan performance.
Originality/value –Although a burgeoning body of literature has examined the underlying factorsthat
affect poor quality loans in both the USA and elsewhere, fewerstudies have focused on loan performance.
From the perspective of banking regulation and fostering banking stability, determining the factors that
affect loan charge-offs is extremely crucial to identify channels through which loan performance is either
worsened or improved.If we understand poor loan performance, we can use thatknowledge to anticipate the
Keywords Panel data, Gramm–leach–Bliley act, US commercial banking, Net loan charge-off rates,
Tier-1 capital ratio
Paper type Research paper
A key feature of the recent ﬁnancial crisis was deterioration in the performance of loans
given by banks. Lax lending standards by bank managers,as well as poor loan monitoring
mechanisms, resulted in sharp rise loan charge-off rates, as well as escalations in non-
performing loans(henceforth, NPLs) of banks in the USA (Ghosh,2015, 2017).
In the USA, banks currently operate under what is called a “incurred loss model.”Inthis
model, loan losses are not recognized in the ﬁnancial statements until a loss has become
probable based on information available as of the date of the ﬁnancial statement. So, when
banks underwrite new loans some portions of these loansare allocated to reserves for loan
losses. Additions to these reserves come from an income statement item, loan loss
provisions, which are set aside as new loans are made and as potential problem loans are
identiﬁed. Often the available information will indicate that there have been losses to the
loan portfolio but those losses cannot yet be attributed to speciﬁc assets. When the losses
can be attributed to individual assets (or the losses are conﬁrmed), the bank is required to
charge-off the loan (OCC’s Handbook,2012).
Once interest becomes overdue on a loan, it is designated “past due”but still accruing
interest, as if interestwas still being paid. If a loan is past due, 90 days or more and accruing
Journalof Financial Regulation
Vol.26 No. 4, 2018
© Emerald Publishing Limited
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