How bad is a bad loan? Distinguishing inherent credit risk from inefficient lending (Does the capital market price this difference?)

Small community banks and the largest experience higher ratios of nonperforming loans than other sizes banks. To what extent does their nonperformance result from lending to riskier borrowers, it a lack proficiency at loan making? Does market discipline punish or reward credit risk proficiency? Using stochastic frontier estimation, we develop technique decompose banks’ ratio total into three components: best-practice representing inherent portfolio, excess inefficiency, statistical noise. We apply decomposition data 2010, 2013, 2016 on top-tier U.S. bank holding companies. The with consolidated assets exceeding $250 billion highest among five size groups. Our shows that high appears not inefficiency lending. Restricting sample publicly traded companies, find is negatively related value except When two components are used instead, uncover more informative underlying story: taking enhances many large value-enhancing effect increases sharply 2010 2016, whereas all so 2016. Market discourage ? incentives both increasing over time.