Loan Loss Reserves, Accounting Constraints, and Bank Ownership Structure
Federal Reserve Banks - Federal Reserve Bank of Richmond
Morgan J. Rose
University of Maryland, Baltimore County; Office of the Comptroller of the Currency
November 17, 2011
This paper examines how the tightening of accounting constraints associated with the SunTrust bank decision in 1998 impacted the loan loss reserve policies of banks differently based on ownership structure. The SunTrust case, the result of an SEC inquiry over possible overstating of loan loss reserves, represented a strengthening of accounting priorities, which stress the importance of the reserve account for financial statement objectivity and comparability, relative to supervisory priorities, which emphasize the role of reserves for bank solvency through changing economic environments. The evidence presented indicates that publicly-held banks, which fall directly under the SECs purview, reduced their loan loss reserve and provisions relative to privately-held banks. Evidence also indicates that the positive relationship between bank earnings and provisions weakened, consistent with a reduction in either earnings management or early recognition of losses.
Number of Pages in PDF File: 40
Keywords: loan loss provisioning, earnings management, income smoothing, ownership structure, financial institutions, banking regulation
JEL Classification: G21, G28, G32, E65
Date posted: November 19, 2011
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