The Effects of Borrowers’ Accounting Conservatism on Lenders’ Loan Loss Provisions: Evidence from China Banking Industry

Abstract

In this paper, I investigate how borrowers’ accounting conservatism affects lenders’ loan loss provisions in Chinese setting. I predict that when borrowers’ financial statements are more conservative, lenders receive borrowers’ bad news in a more timely manner, which in turn induces more loan loss provisions. Empirical results confirm that lenders account more loan loss provisions when borrowers’ accounting conservatism is higher (I refer to this effect as information transfer effects). Additional tests find that the information transfer effects are stronger when borrowers experience negative shocks and lenders are more likely to shift normal loans to non-performances loans when borrowers’ accounting conservatism is higher. Furthermore, cross-sectional tests show that the information transfer effects are stronger if borrowers have higher default risk, information asymmetry, and agency conflicts, if loans are unsecured, without collateral, and short-term, if lenders are not state-owned, listed firms, and with lower reputation.

Keywords: Accounting conservatism; loan loss provisions; micro characteristics, information transfer

JEL Classification: M41 G21