Bank Financial Reporting Opacity and Regulatory Intervention

Abstract

I study the association between bank financial reporting opacity, measured by delayed expected loan loss recognition, and the intervention decisions made by bank regulators. Examining U.S. commercial banks during the 2007-2009 financial crisis, I find that delayed expected loan loss recognition is negatively associated with the likelihood of regulatory intervention (measured by either severe enforcement action or closure). This result is robust to using an extensive set of control variables and various research designs. I consider two alternative mechanisms for this association: whether financial reporting opacity inhibits the effectiveness of regulatory monitoring (regulatory unawareness) or whether regulators practice forbearance on opaque banks (regulatory forbearance). I find evidence consistent with the forbearance mechanism, but not with the unawareness mechanism. My findings contribute to the extant literature on bank opacity, regulatory forbearance, and the consequences of loan loss provisioning by suggesting that delayed expected loan loss recognition may affect regulatory intervention decisions.

Keywords: regulatory intervention, bank closure, enforcement actions, forbearance, loan loss provisioning, banking crises

JEL Classification: G21, G28, M41