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 various specifications and research designs. I consider two alternative mechanisms for this association: financial reporting opacity inhibiting the effectiveness of regulatory monitoring (regulatory unawareness) or regulators practicing forbearance on opaque banks (regulatory forbearance). I find evidence supporting the forbearance mechanism, but not 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 affects regulatory intervention decisions.

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

JEL Classification: G21, G28, M41