Are Banks Really Informed? Evidence From Their Private Credit Assessments

Mehdi Beyhaghi, Cooper Howes, Gregory Weitzner

Abstract
In classic theories of financial intermediation, banks mitigate information frictions
by monitoring and producing information about borrowers. However, it is difficult
to test these theories without being able to observe banks’ private information.
In this paper, we use supervisory data containing banks’ private assessments of
their loans’ expected losses. We show that changes in expected losses predict firms’
future stock returns, bond returns and earnings surprises. The predictability is
concentrated among small firms and growth firms and only occurs when banks
become more pessimistic, consistent with banks specializing in monitoring firms
for negative information. Using within-firm variation in borrowing across banks,
we identify sources of private information for banks and show that this information
affects banks’ credit allocation decisions. Our findings show that banks’ information
production and monitoring creates an information advantage over markets, even
among publicly traded firms.