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The determinants and value relevance of banks' discretionary loan loss provisions during the financial crisis

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  • Morris, Richard D.
  • Kang, Helen
  • Jie, Jing

Abstract

We examine the economic determinants and value relevance of US banks' loan loss provisions (LLP) during the financial crisis. We consider whether LLP is determined by non-discretionary incurred loss variables only, or also by discretionary LLP (DLLP) that smooths reported earnings, signals favourable future earnings, or anticipates future losses. In a sample of 5187 bank-quarter observations from 2006 to 2010, our results show that LLP increases substantially, consistent with it being pro-cyclical, although LLP/equity levels remain modest. LLP severely and negatively impacts reported earnings, especially during 2009–2010. We also find that DLLP is used for smoothing and signalling, primarily where the two incentives reinforce each other, but smoothing occurs more frequently. Further, DLLP anticipated next quarter's losses in 2006–2008 but not in 2009–2010. The market positively values the use of DLLP in 2006–2008 to reduce reported earnings of poorly performing banks, and in 2009–2010 to smooth reported earnings of better performing banks.

Suggested Citation

  • Morris, Richard D. & Kang, Helen & Jie, Jing, 2016. "The determinants and value relevance of banks' discretionary loan loss provisions during the financial crisis," Journal of Contemporary Accounting and Economics, Elsevier, vol. 12(2), pages 176-190.
    • Handle: RePEc:eee:jocaae:v:12:y:2016:i:2:p:176-190
    DOI: 10.1016/j.jcae.2016.07.001
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    4. Alhaj-Ismail, Alaa & Adwan, Sami & Stittle, John, 2019. "Share-option based compensation expense, shareholder returns and financial crisis," Journal of Contemporary Accounting and Economics, Elsevier, vol. 15(1), pages 20-35.
    5. Ozili, Peterson K, 2019. "Bank loan loss provisioning during election years in Nigeria," MPRA Paper 96704, University Library of Munich, Germany.
    6. Tito Tomas Siueia & Jianling Wang, 2017. "Loan Loss Provisions, Income Smooth, Signaling, Capital Management and Pro-Cyclicality: Empirical Evidence from Mozambique¡¯s Commercial Banks," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 9(11), pages 48-63, November.
    7. Jutasompakorn, Pearpilai & Lim, Chu Yeong & Ranasinghe, Tharindra & Ow Yong, Kevin, 2021. "Impact of Basel III on the discretion and timeliness of Banks’ loan loss provisions," Journal of Contemporary Accounting and Economics, Elsevier, vol. 17(2).
    8. Kutubi, Shawgat S. & Ahmed, Kamran & Khan, Hayat & Garg, Mukesh, 2021. "Multiple directorships and the extent of loan loss provisions: Evidence from banks in South Asia," Journal of Contemporary Accounting and Economics, Elsevier, vol. 17(3).
    9. Justin Yiqiang Jin & Yi Liu, 2024. "The Impact of Stock Price Crash Risk on Bank Dividend Payouts," JRFM, MDPI, vol. 17(5), pages 1-25, May.
    10. Ozili, Peterson K, 2020. "Bank loan loss provisioning during election years: cross-country evidence," MPRA Paper 96639, University Library of Munich, Germany.
    11. Ozili, Peterson K, 2019. "Bank loan loss provisions, risk-taking and bank intangibles," MPRA Paper 90273, University Library of Munich, Germany.

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