Participating in PPP increased banks’ risk appetite, study finds

Banks that funneled more government-backed loans to struggling small businesses during the pandemic may have been emboldened to take greater risks in other lending decisions, according to a new academic study.

The Paycheck Protection Program, which launched in April 2020 and wrapped up in May 2021, is widely seen as a successful use of the financial system to relay government assistance to the needy in the middle of a crisis.

But there is evidence that this stockpile of essentially risk-free, low-yielding loans led bank executives to take bigger chances in search of higher profits that they sacrificed as a result of their participation in the PPP, according to the study by three accounting professors, which will be published in the journal Management Science.

The findings go beyond past research that found banks take on more risk when they receive direct government support, such as during the 2008 financial crisis, one of the co-authors, Sarah Stuber of Texas A&M University, said in an interview.

The new paper could give regulators more insight into how banks behave when they are tasked with providing a conduit for government benefits that are targeted for others, she said.

“Anytime you have that amount of money flowing through the bank, it’s going to affect behavior,” Stuber said. “It’s hard for an entity to act purely as a pass-through.”

Stuber and her colleagues — Hailey Ballew at Rice University and Allison Nicoletti at the University of Pennsylvania — looked at banks’ risk appetite in the second and third quarters of last year. Hundreds of billions of dollars in PPP loan proceeds, which are guaranteed by the Small Business Administration, passed through banks both in 2020 and this year.

In 2021 alone, more than $219 billion in PPP loans passed through banks, which equaled about 79% of the total amount approved this year, according to SBA data.

The study’s authors found that a bank with an average PPP participation rate had a relative quarterly increase in risk-weighted assets of 0.32% during the second and third quarters of 2020. That increase compared with an average 0.7% decline in risk-weighted assets across the industry, including those banks that did not participate as fully in the program, they found.

“What we think was probably going on is, when you take on risk-free loans, it increases the risk they perceive they could take on,” Stuber said.

Industry experts who reviewed the study were quick to say that safe PPP loans yielding little profit required bringing on some riskier, higher-earning assets to balance a bank’s portfolio.

Chris Nichols, director of capital markets at $40.3 billion-asset SouthState in Winter Haven, Florida, said that as the pandemic unfolded, banks feared the worst. But when the economy creaked open later in the year, banks suddenly found themselves with more deposits than they needed and had to put the additional capital to work.

While Nichols called the study’s thesis interesting and said the analysis was well run, he argued that it does not fully explain the behavior of banks last year.

“Except for maybe a small handful of bankers, few in our industry ever considered that because of PPP we had additional risk-bearing capacity that we could ‘use’ in other areas,” Nichols said.

Nichols did say that the study helps explain one ripple effect from the Paycheck Protection Program. Because the PPP funneled nearly $800 billion in liquidity to small businesses, it made them safer borrowers on other loans. Small companies may have turned to traditional bank loans in order to meet their supply chain needs, for instance.

The study comes with one major caveat. The authors found that risk-taking appears to have been held in check at some of the larger banks that adopted new Current Expected Credit Losses accounting standards, known as CECL, last year.

Regulators drafted the new requirements to force banks to deepen their analysis of possible losses over the entire life of a loan, rather than set aside allowances for any problems over a much shorter period.

All banks with more than $50 billion of assets had to adopt the new CECL standards at the start of 2020. About 116 smaller financial institutions opted to follow suit at the same time, according to the advisory firm BKD.

The study is among the first to show how the new accounting standards can shape behavior. The authors found no significant relationship between PPP participation and risk-taking for banks that have adopted CECL.

An increase in risk-taking, Stuber explained, would require additional loan-loss reserves under the tougher accounting standards.

The authors state in the paper that further study is needed to draw clearer conclusions about the impact of PPP participation on risk-taking outside of the program. But Stuber said it is clear that lending patterns shifted as a result of the big sums of money that went through the banks.

“It’s important for policymakers to understand how they administer these programs and the effects on banks as we see more stimulus programs coming out,” she said.

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