Modeling loan losses a macroeconomic approach

A sound banking system is essential to a well-functioning economy. With the financial crisis beginning in 2007, a renewed interest in the safety of financial institutions has dominated both the political and financial landscape. Mounting loan losses in real estate lending led to the failing of over 460 banks from 2008 to 2012. This crisis is not unique; in fact, the Savings & Loan Crisis of the 1980\u27s to early 1990\u27s led to the closure of 700 savings institutions. Both instances created a panic in financial markets and heavy losses to deposit insurance funds. These losses are ultimately borne by taxpayers and prudently managed banks, especially if the insurance fund requires re-capitalization. The focus of this paper is on explaining the contributing factors to different categories of loan losses. Namely, total loan losses, residential real estate loan losses, commercial real estate loan losses, and commercial and industrial loan losses are examined. A multivariate regression approach is taken in this paper to explain the four rates of loan losses for the period of 2001 to 2012. Aggregate macroeconomic data from 2001 to 2012 is used to explain loan losses across categories. It was found that the delinquency rate of loans, the consumer financial obligations ratio, and the financial crisis were all significant factors in explaining loan losses