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Managerial Discretion Over Loan Loss Reserves during the Global Financial Crisis

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  • Glen Hansen

Abstract

I analyze loan loss reserves during the Global Financial Crises in the late 2000s. I develop a regression model that separates the loan loss reserve account into discretionary and nondiscretionary components. The nondiscretionary (expected) component is based on current, past due, restructured, and non-accrual loans. The discretionary reserves component is the residual from the regression model. This component measures both managerial misinformation and managerial miscalculations since it is unrelated to the quality of the loan portfolio. I find that loan quality decreased during the financial crisis as shown by an increase in lower quality loans (restructured, past due, and non-accrual loans). Managers also set aside more loan loss reserves during the financial crisis. This paper demonstrates that all of the increase in the loan loss reserve account is attributable to the nondiscretionary component of loan loss reserves. The discretionary reserves component actually decreased during the financial crises consistent with managers using their discretion to window-dress their balance sheets and improve outside perception of the banking industry financial condition.

Suggested Citation

  • Glen Hansen, 2015. "Managerial Discretion Over Loan Loss Reserves during the Global Financial Crisis," The International Journal of Business and Finance Research, The Institute for Business and Finance Research, vol. 9(1), pages 51-61.
    • Handle: RePEc:ibf:ijbfre:v:9:y:2015:i:1:p:51-61
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    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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