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Discretionary loan loss provisioning and bank stock returns: The Role of economic booms and busts

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  • Hegde, Shantaram P.
  • Kozlowski, Steven E.

Abstract

We provide evidence that discretionary loan loss provisions (DLLP) convey value-relevant information to the market that is highly dependent upon the state of the economy. DLLP is associated with negative abnormal returns during bad economic states characterized by growing default concerns, but it is associated with significantly higher abnormal stock returns in good economic states, as banks relax underwriting standards and look to accelerate loan growth. Exploring the underlying link, we find that banks recording higher provisions during good times realize significantly higher earnings and loan growth in the subsequent year, whereas such banks experience further increases in non-performing loans following periods of distress. These findings are not driven by the 2008 financial crisis when investors responded even more negatively to DLLP. With new accounting standards requiring an even greater degree of subjective judgment, regulators should ensure the informativeness of bank loss reserves is preserved.

Suggested Citation

  • Hegde, Shantaram P. & Kozlowski, Steven E., 2021. "Discretionary loan loss provisioning and bank stock returns: The Role of economic booms and busts," Journal of Banking & Finance, Elsevier, vol. 130(C).
    • Handle: RePEc:eee:jbfina:v:130:y:2021:i:c:s037842662100145x
    DOI: 10.1016/j.jbankfin.2021.106186
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    More about this item

    Keywords

    Loan loss provision; Bank holding company; Business cycle; Lending standards; Valuation; Bank lending;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General

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