Does Greater Transparency Discipline the Loan Loss Provisioning of Privately Held Banks?
77 Pages Posted: 5 Oct 2023 Last revised: 11 Dec 2023
Date Written: October 5, 2023
Whether transparency helps or hurts the stability of the financial system is an unresolved question. Recent trends have seen a decline in disclosure requirements especially for small and privately held banks. We investigate the relationship between the transparency of loan loss provision disclosures and the provisioning practices of privately held banks. We study a unique change in disclosure regulation under German banking law which introduces mandatory disclosures of loan loss provisions. Using proprietary data provided by the national supervisor, we are able to observe provisioning practices before and after disclosure becomes mandatory. Our findings suggest that bank managers use loan loss provisions to a lesser extent for income smoothing once they are required to disclose their accounting choice. At the same time, provisions become timelier and loan portfolio quality improves. The change comes in the absence of capital market pressure and highlights the role of depositors and public pressure in the monitoring and disciplining of bank managers. Overall, these findings support the view that bank transparency helps establish financial stability.
Keywords: Bank Transparency, Earnings Smoothing, Loan Loss Provisions, Market Discipline, Privately Held Banks, Public Disclosure
JEL Classification: G21, G28, M41, M48
Suggested Citation: Suggested Citation