The Effect of Corporate Taxation on Bank Transparency: Evidence from Loan Loss Provisions
60 Pages Posted: 15 Feb 2016 Last revised: 28 Sep 2017
Date Written: January 1, 2017
We examine how the corporate tax system, through its treatment of loan losses, affects bank financial reporting choices. Our identification strategy exploits cross-country and intertemporal variation in corporate tax rates and the tax deductibility of loan loss provisions. Using an international sample of banks, we find that the loan loss provision is increasing in the corporate tax rate for countries that permit the tax deduction of general provisions. The effect is economically significant: when allowing general provision deductibility, a 1 percentage point increase in the corporate tax rate leads to an increase in provisions of approximately 4.9% of the sample average. Furthermore, we show that this effect is driven by the corporate tax system’s encouragement of timelier loan loss recognition: the extent to which future and current loan portfolio quality deteriorations are incorporated into the loan loss provision is increasing in the tax rate when general provisions are tax deductible. Overall, our results suggest that the corporate tax system is an important determinant of timely loan loss recognition and hence the financial reporting transparency of the banking sector.
Keywords: bank transparency, bank regulation, loan loss provisions, corporate taxation
JEL Classification: G21, G28, H25, M41
Suggested Citation: Suggested Citation