Bank Loan Loss Provisions: A Reexamination of Capital Management, Earnings Management and Signaling Effects

Abstract

This paper exploits the 1990 change in capital adequacy regulations to construct more powerful tests of capital and earnings management effects on bank loan loss provisions. We find strong support for the hypothesis that loan loss provisions are used for capital management. We do not find evidence of earnings management via loan loss provisions. We also document the reasons for the conflicting results on these effects observed in prior studies. Additionally, we find that loan loss provisions are negatively related to both future earnings changes and contemporaneous stock returns contrary to the signaling results documented in prior work.

JEL Classification: M41, M43, G21, K23