Belief Distortions and Lending Cyclicality: Evidence from Industry-Specialized Banks

This paper studies how industry specialization affects banks’ belief formation and lending over the credit cycle. I show that when a specialized bank’s preferred industry experiences a stock market runup, the bank expands lending and reduces loan loss provisions without tightening loan terms, despite the fact that industry performance declines from its runup period peak in the years that follow. Loans originated under these conditions have a 62 basis point higher default rate than comparable loans made by nonspecialized banks to the same industry. Consistent with a diagnostic expectations framework, earnings call sentiment analysis reveals that specialized banks express heightened optimism toward their preferred industries during booms. The results highlight a downside of expertise in financial intermediation: specialization can amplify credit cycles by distorting beliefs.

Recommended citation: Daniel, Ezra. (2026). "Belief Distortions and Lending Cyclicality: Evidence from Industry-Specialized Banks." Working paper.
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