The effect of networking on bad loans: evidence from mutual banks

Since the territoriality of small cooperative banks is limited, network effects can prevail across the bad loans of mutual banks that operate in the same geographical district. It is worth noting that the credit recovery policies of local banks can have a cascading effect on the quality of neighboring banks' loan portfolios. The current study provides compelling evidence that bad loans are geographically contemporaneous and lagged dependent. The two spatial terms, in particular, have opposed effects: the contemporaneous spatial lag term has a direct effect, whereas the space-time autoregressive coeffcient has a negative effect. In contrast to the contemporaneous effect, which can be attributed to business cycle fluctations, the time-spatial lag effect confirms the insight that neighboring financial institutions' credit recovery policies can have a detrimental effect on the credit recovery capacities of local banks. Finally, the empirical model depicts a significant relationship between the Lerner index and non-performing loans. This compelling evidence supports the hypothesis of competition-stability.