The Politics of Implementing Bank Reporting Regulation: Evidence from China

Abstract

We investigate whether state-owned banks respond to the adoption of a forward-looking provisioning model and whether their responses are affected by politicians’ career incentives. Using the mandatory shift to the expected credit loss model in China, we find that the increases in the magnitudes and timeliness of loan loss provisions following the mandatory shift are smaller for state-owned banks with local governors in late term of their appointment, referred to as banks with high-incentive governors. Additional analysis suggests that connections with asset management companies facilitate underreporting of provisions. Further, relative to other treatment banks, banks with high-incentive governors prior to the COVID recession experience greater lending reductions and face more fraud charges during the recession. Overall, our findings suggest that politicians’ career incentives lead to opportunistic underreporting of provisions and dampen the effectiveness of financial reporting regulation in reducing lending procyclicality.

Keywords: Bank financial reporting; IFRS 9; Loan loss provision; State-owned banks