The effects of policy uncertainty on bank loan loss provisions

Abstract

Uncertainty around fiscal policy has the potential to alter the lending behavior, investment, and employment of bank holding companies, all of which affect a bank's bottom line. Management forecasts of loan losses exhibit greater dispersion during these periods. However, this uncertainty provides management greater flexibility in estimating loan loss provisions to achieve firm objectives. Using a sample of 2483 U.S. bank holding companies, we demonstrate that the positive relationship between economic policy uncertainty and discretionary loan loss provisions is contingent on BHC characteristics and stakeholder oversight. The presence of institutional investors, increased analyst following, and dividend issuance attenuates the positive relationship between policy uncertainty and discretionary loan loss provisions. We also find that increased regulatory scrutiny weakens this relationship. Our findings indicate policy uncertainty provides cover to managements' inaccurate adjustments of loan loss provisions, but management is less willing to make such adjustments when internal and external stakeholders are informed.