How does bank opacity affect credit growth and return predictability?

Prior research finds that bank credit growth predicts lower bank equity returns in subsequent one to three years. Stocks of banks with high credit growth are initially overvalued because of overoptimism or elevated sentiment of bank shareholders. Eventually, these stocks underperform, generating lower returns. We argue that shareholder sentiment should exhibit its strongest effects on the performance of bank stocks when banks are opaque, or there is uncertainty about the quality of bank loans. Accordingly, we show that an increase in bank’s financial reporting opacity amplifies the predictive ability of credit growth for equity returns by 3 to 4 times relative to when opacity is at its mean. • We examine how bank opacity affects predictability of equity return from credit growth. • Rise in bank opacity amplifies the return predictability of credit growth. • When opacity increases, credit growth predicts a sharper decline in future returns. • Our results align with sentiments mainly affecting stocks with high uncertainty.