Ratio of loan/TA can have a negative impact on risk if the variable is acting as a proxy for non-performing assets / TA

Ahokpossi (2013) IMF paper WP/13/34 uses loan/TA as a measure of credit risk

Ratio of loan/TA can have a negative impact on risk if the variable is acting as a proxy for performing assets / TA

Ahokpossi (2013) IMF paper WP/13/34 uses loan/TA as a measure of credit ris

where performing assets/TA = (1- non-performing assets/TA)

Thanks for your contribution Sree.

There is a possibility that that the above explanation is valid. Another reason may be that as the loans increase the level of variation in return decreases i.e. the standard deviation goes down due to more prudent policies and precaution. We know that higher sample size reduces the standard deviation because of the averaging out of deviations. This might the reason for your result

Thanks very much Utkarsh, it seems convincing.

I didn't handled closely with this topic but I believe that the global financial and economic crisis in the economy atrophied in many cases the natural reactions of the markets. I think that all loans have fallen into obscurity and are perceived as risky, especially in Europe, where lending (predominantly from banking system) is the main source of financing for the firms (especially small ones). Here it might be interesting a discussion about perception of debt, and would be interesting to analyze separately the problem of loans and assets: volume, structure and quality. Both items may contain a big negative perception of their quality. Information or rather lack of information, which stands behind the two elements of this report, makes them (loans and TA) to be treated as risky, therefore the conclusions should not be expressed in verdicts.

Thanks Alina for your answer.

I would need more information on the way you run your model. Assuming what you mean by loans is commercial and private client loans, my first reaction as an ex banker is that the lower the loans/TA ratio is, the higher the non clients loans/TA is. Now banks usually place their excess cash in government bonds or interbank loans that typically are considered less risky and therefore total risk decreases.

I am not sure this answers your question but it might give you another trail to be explored.

Thanks Robert, that is absolutely true and your opinion is proven in most of the literature. Another explanation is that as loan/TA increase the default and liquidity risk increase thus the bank's risk increase and vice versa.

Although, what I am getting is something against yours and the above mentioned explanations. That is, as loan/TA increases the the banks risk decreases.

I should go with the explanation mentioned by Sree Rama Murthy Y.

Kind Regards,

Ahmad, your result is surprising and I wonder if it does not have to do with your risk model. If you apply the BIS rules for measuring credit risks in bank assets, I think the result might be opposite to what you are getting. In any case, I would compare your model to regulators recommendations

As for your question, I cannot comment on Sree answer before I read the IMF paper he mentions..

I will revert on this

Ahmad,

My guess is following:

Assets of the banks you analyse are:

Total Assets = Loans + (Stocks + Bonds + Treasuries + Balance Sheet Value of Derivatives + Other)

The lower Loans/TA, the higher share of Stocks, Bonds, Treasuries, Derivatives etc. If you are looking at European banks (universal like Deutsche Bank as opposed to US standard commercial/investment split), it is a probably Non-Loan portfolio that drove the volatility of banks' returns.

Derivatives, Stock Crashes, Greek Treasury Bonds, CDS, MBS, you name it. Maybe - compared to them loan portfolios were not so much volatile (they are not marked to market etc., derivative leverage is much bigger than loan leverage)

I would have to look for previous studies, but maybe my "guess" can help you here.

Which banks, what period, what database are you using?