Publication Type
Journal Article
Publication Date
1-2014
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
Publication
Review of Accounting Studies
ISSN
1380-6653
Citation
NG, Tee Yong Jeffrey and Roychowdhury, Sugata.
Loan loss reserves, regulatory capital, and bank failures: evidence from the recent economic crisis. (2014). Review of Accounting Studies.
Available at: https://ink.library.smu.edu.sg/soa_research/1192
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