The Relevance of Discretionary Loan Loss Provisions During the Financial Crisis

52 Pages Posted: 8 Sep 2016 Last revised: 22 May 2019

See all articles by Paul J. Beck

Paul J. Beck

University of Illinois at Urbana-Champaign - Department of Accountancy

Zhenhua Chen

University of San Diego School of Business

Bin Li

University of Houston - Department of Accountancy & Taxation

Ganapathi S. Narayanamoorthy

Tulane University - Accounting & Taxation

Date Written: May 20, 2019

Abstract

Banks’ use of accounting discretion in estimating loan loss provisions (LLPs) during the financial crisis has come under severe criticism. We argue, however, that it is during periods of instability like the financial crisis that accounting discretion is most relevant. We find that the discretionary component of LLPs exhibits dramatically stronger associations with contemporaneous stock returns and with subsequent realized loan losses during the crisis than in surrounding periods. We also find that discretionary LLPs are associated with the Treasury’s allocation of TARP funds. Tests surrounding the TARP funding shock provided added validity to our empirical specifications. The significant beneficial role of discretion in LLPs during the financial crisis is especially important in light of the FASB’s new accounting rules that are likely to alter the level of accounting discretion underlying these estimates.

Keywords: Financial Crisis; Banks; TARP; Loan Loss Provisions; Accounting Discretion; Value Relevance

JEL Classification: G01; G21; G28; M41

Suggested Citation

Beck, Paul J. and Chen, Zhenhua and Li, Bin and Narayanamoorthy, Ganapathi S., The Relevance of Discretionary Loan Loss Provisions During the Financial Crisis (May 20, 2019). Available at SSRN: https://ssrn.com/abstract=2835606 or http://dx.doi.org/10.2139/ssrn.2835606

Paul J. Beck

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

1206 South Sixth Street
293 Commerce West
Champaign, IL 61820
United States
217-333-4563 (Phone)
217-244-3118 (Fax)

Zhenhua Chen (Contact Author)

University of San Diego School of Business ( email )

Olin Hall
5998 Alcalá Park
San Diego, CA
United States

Bin Li

University of Houston - Department of Accountancy & Taxation ( email )

Bauer College of Business
4800 Calhoun Road
Houston, TX 77204
United States

Ganapathi S. Narayanamoorthy

Tulane University - Accounting & Taxation ( email )

United States

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