Does Disaster Risk Relate to Banks’ Loan Loss Provision Estimates?

Lorenzo Dal Maso (), Kiridaran Kanagaretnam (), Gerald Lobo () and Francesco Mazzi ()
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Lorenzo Dal Maso: University of Bologna
Kiridaran Kanagaretnam: Schulich School of Business
Gerald Lobo: University of Houston
Francesco Mazzi: University of Florence

Working Papers - Business from Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa

Abstract: We examine the relation between disaster risk and banks’ loan loss provision (LLP) estimates. We propose a disaster risk measure based on the natural disasters declared as major disasters by the Federal Emergency Management Agency over the past fifteen years. We theoretically support and empirically validate our measure using three different approaches, including the UN Sendai Framework for disaster risk reduction, which relates disaster risk to natural hazard exposure, vulnerability and capacity, and hazard characteristics. Using more than 445,000 bank-quarter observations, we document that banks located in counties with higher disaster risk recognize larger LLP after controlling for other bank-level factors related to LLP estimates. We employ several techniques to ensure the robustness of our findings, including difference-in-differences estimation and matched samples. In additional analysis, we propose three alternative measures of disaster risk, explore the characteristics that better enable banks to recognize disaster risk in their LLP estimates, and investigate the consequences of managing disaster risk through LLP. Our results are important, especially because of the increasing concern about disaster risk and because they inform the growing debate on the economic consequences of disaster risk and the ability of the banking system to proactively manage the resulting credit risk through LLPs.

Keywords: Disaster Risk; Loan Loss Provisions; Future Charge-offs; Future Risk-Taking; Banks (search for similar items in EconPapers)
JEL-codes: E50 E59 G20 G21 M40 M41 (search for similar items in EconPapers)
Pages: 63 pages
Date: 2022
New Economics Papers: this item is included in nep-ban and nep-rmg
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