Publication Type

Journal Article

Version

submittedVersion

Publication Date

9-2014

Abstract

Regulatory capital guidelines allow for loan loss reserves to be added back as capital. The evidence in this paper suggests that the influence of loan loss reserves added back as regulatory capital (hereafter referred to as “add-backs”) on bank risk cannot be explained by either economic principles underlying the notion of capital, or accounting principles underlying the recording of reserves. Specifically, we observe that in sharp contrast to the economic notion of capital as a buffer against bank failure risk, add-backs are positively associated with the risk of bank failure during the recent economic crisis. Further the positive association of add-backs with bank failure risk is concentrated among cases in which the add-backs are highly likely to increase a bank’s total regulatory capital. The evidence cannot thus be fully explained by accounting principles either, since the role of loan loss reserves according to those principles does not depend on whether the reserves generate a regulatory capital increase. Additional analysis suggests that the observed influence of loan loss reserves on bank failure risk may be an unintended consequence of their regulatory treatment as capital.

Keywords

bank failure, bank risk, regulatory capital, capital adequacy, loan loss reserves, loan loss provisions

Discipline

Accounting | Finance and Financial Management

Research Areas

Financial Performance Analysis

Publication

Review of Accounting Studies

Volume

19

Issue

3

First Page

1234

Last Page

1279

ISSN

1380-6653

Identifier

10.1007/s11142-014-9281-z

Publisher

Springer

Embargo Period

2-23-2014

Copyright Owner and License

Authors

Additional URL

https://doi.org/10.1007/s11142-014-9281-z

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