Loan Loss Accounting and Procyclical Bank Lending: The Role of Direct Regulatory Actions

Abstract

I provide evidence that loan loss accounting affects procyclical lending through its impact on regulatory actions. Regulators are more likely to place banks with inadequate loan loss allowances under enforcement actions that restrict lending, leading these banks to lend less during downturns. Further, I find that banks with lower regulatory ratings lend less when they have more timely provisions, consistent with research theorizing that timely provisions increase transparency and inhibit regulatory forbearance. This regulatory action mechanism expands on prior research that has focused on the effect of loan loss recognition on regulatory capital adequacy during economic downturns.

Keywords: Banking, allowance for loan losses, loan loss provisions, regulation, procyclicality

JEL Classification: G18, G21, G28, M41