When the Economy Is Overheating, Banks Lend Farther from Home

When bankers went farther from branch offices, the loans they made defaulted at much higher rates than loans to businesses closer to branches.

Competition for loans partly drives the expansion far beyond bank branches during an economic boom, the research suggests. In the run-up to the 2008 crisis, the entry of a new large bank in a market, for example, spurred local banks to go looking for less-competitive markets and pick up customers further afield. Banks in the most competitive markets expanded lending distances considerably, just to see these distances contract during the Great Recession. By contrast, banks without much competition did not stretch and shrink the areas where they offered loans over the entire economic cycle.

And just as banks looked farther away for loans in good times, when the economy weakened, they contracted to focus on local lending, the researchers find. In recessions, banks dramatically shrunk their lending territories.

Banks already report a litany of complex data about their loan portfolios to help regulators assess risks. But monitoring the average distance from originating branches to small-business customers may give regulators an early warning of trouble ahead, the research suggests. “Since distance is easily measurable,” the researchers write, “it is a metric that bank supervisors could easily track as they monitor lending standards in the economy.” They add one notable caveat: if regulators do start using the metric, that will likely change its usefulness—and bank behavior.