Banks' Use of Accounting Discretion and Regulatory Intervention: The Case of European Banks' Impairments on Greek Government Bonds

Abstract

This paper analyzes troubled banks' use of accounting discretion and its interaction with regulatory intervention in a time of financial distress. We analyze impairment losses that Europe's largest banks recognized on Greek Government Bonds (GGB) during 2011, the time during which GGB were considered impaired. Our findings reveal considerable variation in the impairment ratios across banks. Banks with larger GGB exposures, for which a full impairment would deplete a large share of regulatory capital, recognize significantly lower impairment ratios. Furthermore, we find that troubled banks delay full impairments until state aid is provided. Troubled banks recognize significantly lower impairment ratios in the quarter before they are provided with state aid, but substantially increase their impairment ratios afterwards. This pattern is consistent with the notion that troubled banks initially understate impairments to conceal the full extent of their financial difficulties from less sophisticated non-regulator outsiders (e.g., depositors and the general public), which increases regulators' ability to practice forbearance by not intervening immediately.