Loan Loss Reserves, Accounting Constraints, and Bank Ownership Structure

Abstract

This paper examines how the tightening of accounting constraints associated with the SunTrust bank decision in 1998 impacted the loan loss reserve policies of banks differently based on ownership structure. The SunTrust case, the result of an SEC inquiry over possible overstating of loan loss reserves, represented a strengthening of accounting priorities, which stress the importance of the reserve account for financial statement objectivity and comparability, relative to supervisory priorities, which emphasize the role of reserves for bank solvency through changing economic environments. The evidence presented indicates that publicly held banks, which fall directly under the SECs purview, reduced their loan loss reserve and provisions relative to privately held banks. Evidence also indicates that the positive relationship between bank earnings and provisions weakened, consistent with a reduction in either earnings management or early recognition of losses.

Risk Management and Regulation

“…Accountants expected to be guided by the principles of financial statement objectivity and comparability, while supervisors saw mainly through the lens of bank solvency over the credit cycle (Balla and Rose 2012). This potential conflict had emerged clearly in the United States in the late 1990s, when, possibly as a result of an SEC inquiry about the overstatement of loan loss reserves by SunTrust, a reduction was observed in the provisioning of publicly listed banks (subject to the SEC's purview) as opposed to privately owned banks (Balla and Rose 2012). The partial fixes under the IRB approach of Basel II did soothe the regulators' concerns about bank provisions' adequacy, but only up to a point.…”

Are Banks Forward-Looking in Their Loan Loss Provisioning? Evidence from the Senior Loan Officer Opinion Survey (SLOOS)

“…Accountants on the other hand, take an incurred loss approach. This means that a bank makes a provision to the loan loss reserve account only if the loss has been incurred (Also refer to Whalen 1994, Balla and Rose 2009) 4 . The incurred loss approach to loan loss provisioning involves setting aside earnings to cover anticipated losses on loans in default.…”

Do Delays in Banks' Loan Loss Provisioning Affect Economic Downturns? Evidence from the U.S. Housing Market

“…Whereas regulators advocate for early loan loss recognition, the SEC opposes excessive early recognition, because it views this practice as building cookie jar reserves to smooth income(Beck and Narayanamoorthy, 2013;Balla and Rose, 2015;Jayaraman et al, 2017). The SEC's litigation against SunTrust Bank in 1998 for its overprovisioning led the SEC to issue guidance for loan loss provisioning practices.17 After the SunTrust case, the SEC issued Staff Accounting Bulletin (SAB) 102 in July 2001 to discourage recognizing excessive expected loan losses Balla and Rose (2015). provide evidence that public banks changed their practices in response to the SEC's intervention more than privately held banks, suggesting that SAB 102 created an exogenous shift to the timing of public banks' loan loss provisioning.…”

“…The SEC was concerned that U.S. public banks were systematically overstating their loan loss reserves in 1997. In 1998, the SEC required SunTrust Banks to reverse its loan loss reserve by $100 million by restating its earnings for 1994-1996(Balla and Rose, 2015).18 I consider the following SEC offices: headquarters -Washington D.C.; regional offices -New York City; Miami; Chicago; Denver; Los Angeles. District offices are excluded followingKedia and Rajgopal (2011).…”