Abstract

After the 2008 global financial crisis, U.S. bank holding companies needing to cover larger-than-expected loan losses raised concerns that existing provision accounting may be procyclical. Most related studies have found evidence of procyclicality using either aggregate time-series data or “as-reported” panel data. We test the null hypothesis that provisions were a constant fraction of nonperforming loans across the economic cycle. We create a “forced” panel, which incorporates the entities acquired by each holding company in the quarters prior to their mergers. As in the related literature, we fail to reject the null hypothesis with “as-reported” data; however, we reject the null hypothesis with the “forced” panel. This finding suggests that holding companies built up provisions to some degree during the pre-crisis period to cover larger future losses. These actions reduced capital and likely depressed lending in the pre-crisis period; such countercyclical impacts are consistent with post-crisis macroprudential policies.

Highlights

  • Most related studies have found evidence of procyclicality using either aggregate time-series data or “as-reported” panel data

  • After the 2008 global financial crisis, U.S bank holding companies needing to cover larger than expected loan losses raised concerns that existing provision accounting may be procyclical—i.e., banks under provision for loan losses in economic expansions allow for higher dividend payouts and more aggressive lending, so they need to dramatically increase provisions in a downturn, resulting in reduced earnings, capital, and lending

  • We revisited whether the incurred loss (IL) standard as implemented by large U.S bank holding companies has been procyclical using regulatory reports filed over the last two decades

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Summary

Introduction

Most related studies have found evidence of procyclicality using either aggregate time-series data or “as-reported” panel data. As in the related literature, we fail to reject the null hypothesis with “as-reported” data; we reject the null hypothesis with the “forced” panel This finding suggests that holding companies built up provisions to some degree during the pre-crisis period to cover larger future losses. By delaying the recognition of expected losses under the IL standard, greater provisions were required during the downturn, and capital requirements were more likely to be binding than otherwise (see, for example, Bernanke 2009 and Van den Heuvel 2009) Together, these assertions suggest that provisioning was viewed as “too procyclical” under the IL standard, and this procyclicality contributed to the observed severe economic downturn during the financial crisis.

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