European Central Bank working paper finds sector-specialised banks detect corporate default risk earlier

The European Central Bank published a working paper analysing whether banks’ sectoral loan-portfolio specialisation gives them an informational advantage in credit risk assessment. Using euro area credit register data, it finds that banks specialised in a borrower’s sector predict future corporate defaults earlier than non-specialised banks assessing the same firm. Across the quarters leading up to default, specialised banks assign higher ex-ante probabilities of default, with a gap of about 3.8 percentage points four quarters before default, and this advantage is largely driven by earlier increases in probabilities of default rather than higher risk assessments at loan origination. The paper also finds that specialised banks raise provisions for later-defaulting borrowers accordingly, observes no difference in risk assessment for healthy borrowers (suggesting the effect is not general conservatism), and reports stronger results for smaller firms and when banks do not have long-term relationships with the defaulting borrowers.