Skip to main content
×
×
Home

The Effect of Credit Competition on Banks’ Loan-Loss Provisions

  • Yiwei Dou, Stephen G. Ryan and Youli Zou
Abstract

Exploiting differential interstate-branching deregulation across contiguous counties of adjacent states, we investigate the effect of entry threat on incumbent banks’ loan-loss provisions. Incumbents exposed to entry threat have offsetting incentives; lower provisions make their loan-underwriting quality appear better, deterring entry, but make local economic conditions appear better, encouraging entry. We find that the incentive to increase apparent loan-underwriting quality dominates on average. We further find that this incentive is stronger in counties with a higher proportion of heterogeneous loans, while the other incentive dominates in counties with both low heterogeneous loans and highly volatile economic conditions.

Copyright
Corresponding author
* Dou (corresponding author), ydou@stern.nyu.edu, and Ryan, sryan@stern.nyu.edu, New York University Stern School of Business; Zou, yzou@gwu.edu, George Washington University School of Business.
Footnotes
Hide All
1

We thank Tara Rice for providing her state-level interstate branching restriction data and Allan Collard-Wexler for providing his contiguous-county data. We thank Dick Sylla and Larry White for insights regarding the historical development of bank regulation. We thank Jeff Callen, Daniel Cohen, Giovanni Dell’Ariccia (the referee), Richard Frankel, Wayne Guay, Scott Liao, Alvis Lo, Paul Malatesta (the editor), and seminar participants at New York University, Leeds University Business School, the 2013 NYU summer camp, the 2013 London Business School symposium, the 2013 Yale fall conference, the 2013 American Accounting Association annual meeting, and Georgetown University for useful comments on prior versions of the paper.

Footnotes
References
Hide All
Ahmed, A.; Takeda, C.; and Thomas, S.. “Bank Loan Loss Provisions: A Reexamination of Capital Management, Earnings Management and Signaling Effects.” Journal of Accounting and Economics, 28 (1999), 125.
Akins, B.; Dou, Y.; and Ng, J.. “Corruption in Bank Lending: The Role of Timely Loan Loss Recognition.” Journal of Accounting and Economics, 63 (2017), 454478.
Akins, B.; Li, L.; Ng, J.; and Rusticus, T.. “Bank Competition and Financial Stability: Evidence from the Financial Crisis.” Journal of Financial and Quantitative Analysis, 51 (2016), 128.
Angrist, J., and Pischke, J.. Mostly Harmless Econometrics: An Empiricist’s Companion. Princeton, NJ: Princeton University Press (2009).
Armstrong, C.; Balakrishnan, K.; and Cohen, D.. “Corporate Governance and the Information Environment: Evidence from State Antitakeover Laws.” Journal of Accounting and Economics, 53 (2012), 185204.
Ashcraft, A.Are Banks Really Special? New Evidence from the FDIC-Induced Failure of Healthy Banks.” American Economic Review, 95 (2005), 17121730.
Bamber, L. S., and Cheon, Y. S.. “Discretionary Management Earnings Forecast Disclosures: Antecedents and Outcomes Associated with Forecast Venue and Forecast Specificity Choices.” Journal of Accounting Research, 36 (1998), 167190.
Beatty, A.; Chamberlain, S.; and Magliolo, J.. “Managing Financial Reports of Commercial Banks: The Influence of Taxes, Regulatory Capital, and Earnings.” Journal of Accounting Research, 33 (1995), 231261.
Beatty, A.; Ke, B.; and Petroni, K.. “Earnings Management to Avoid Earnings Declines across Publicly and Privately Held Banks.” Accounting Review, 77 (2002), 547570.
Beatty, A., and Liao, S.. “Do Delays in Expected Loss Recognition Affect Banks’ Willingness to Lend?” Journal of Accounting and Economics, 52 (2011), 120.
Beatty, A., and Liao, S.. “Financial Accounting in the Banking Industry: A Review of the Empirical Literature.” Journal of Accounting and Economics, 58 (2014), 339383.
Beaver, W.; Eger, C.; Ryan, S.; and Wolfson, M.. “Financial Reporting, Supplemental Disclosure, and Bank Share Prices.” Journal of Accounting Research, 27 (1989), 157178.
Beck, T.; Levine, R.; and Levkov, A.. “Big Bad Banks? The Winners and Losers from Bank Deregulation in the United States.” Journal of Finance, 65 (2010), 16371667.
Becker, B.Geographical Segmentation of US Capital Markets.” Journal of Financial Economics, 85 (2007), 151178.
Bens, D.; Berger, P.; and Monahan, S.. “Discretionary Disclosure in Financial Reporting: An Examination Comparing Internal Firm Data to Externally Reported Segment Data.” Accounting Review, 86 (2011), 417449.
Berger, A.; Demsetz, R.; and Strahan, P.. “The Consolidation of the Financial Services Industry: Causes, Consequences, and Implications for the Future.” Journal of Banking and Finance, 23 (1999), 135194.
Berger, A., and Dick, A.. “Entry into Banking Markets and the Early-Mover Advantage.” Journal of Money, Credit and Banking, 39 (2007), 775807.
Berger, A; Kashyap, A.; and Scalise, J.. “The Transformation of the U.S. Banking Industry: What a Long, Strange Trip It’s Been.” Brookings Papers on Economic Activity, 2 (1995), 55218.
Berger, A., and Udell, G.. “Small Business Credit Availability and Relationship Lending: The Importance of Bank Organizational Structure.” Economic Journal, 112 (2002), F32F53.
Bernard, D.Is the Risk of Product Market Predation a Cost of Disclosure?” Journal of Accounting and Economics, 62 (2016), 305325.
Bertrand, M., and Mullainathan, S.. “Enjoying the Quiet Life? Managerial Behavior Following Anti-Takeover Legislation.” Journal of Political Economy, 111 (2003), 10421075.
Bhat, G.; Lee, J.; and Ryan, S.. “Using Loan Loss Indicators by Loan Type to Sharpen the Evaluation of Banks’ Loan Loss Accruals.” Working paper, Southern Methodist University (2016).
Bhat, G.; Ryan, S.; and Vyas, D.. “The Implications of Credit Risk Modeling for Banks’ Loan Loss Provision Timeliness and Loan Origination Procyclicality.” Working paper, New York University (2017).
Black, S.Do Better Schools Matter? Parental Valuation of Elementary Education.” Quarterly Journal of Economics, 114 (1999), 577599.
Boyd, J., and De Nicolo, G.. “The Theory of Bank Risk Taking and Competition Revisited.” Journal of Finance, 60 (2005), 13291343.
Breitkopf, D.Great Florida Builds Up as Others Lick Wounds.” American Banker, 173 (2008), 56.
Broecker, T.Credit-Worthiness Tests and Interbank Competition.” Econometrica, 58 (1990), 429452.
Burks, J.; Cuny, C.; Gerakos, J.; and Granja, J.. “Competition and Voluntary Disclosure: Evidence from Deregulation in the Banking Industry.” Working Paper, University of Chicago (2017).
Bushman, R.; Hendricks, B.; and Williams, C.. “Bank Competition: Measurement, Decision-Making, and Risk-Taking.” Journal of Accounting Research, 54 (2016), 777826.
Bushman, R., and Williams, C.. “Accounting Discretion, Loan Loss Provisioning, and Discipline of Banks’ Risk-Taking.” Journal of Accounting and Economics, 54 (2012), 118.
Bushman, R., and Williams, C.. “Delayed Expected Loss Recognition and the Risk Profile of Banks.” Journal of Accounting Research, 53 (2015), 511553.
Calem, P.“The Impact of Geographic Deregulation on Small Banks.” Business Review, Federal Reserve Bank of Philadelphia, November/December (1994), 17–31.
Callen, J.; Chen, F.; Dou, Y.; and Xin, B.. “Accounting Conservatism and Performance Covenants: A Signaling Approach.” Contemporary Accounting Research, 33 (2016), 961988.
Callen, J.; Guan, Y.; and Qiu, J.. “The Market for Corporate Control and Accounting Conservatism.” Working Paper, University of Toronto (2014).
Calomiris, C., and Mason, J.. “Consequences of Bank Distress during the Great Depression.” American Economic Review, 93 (2003), 937947.
Card, D., and Kruger, A.. “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania.” American Economic Review, 84 (1994), 772793.
Clair, R.; O’Driscoll, G. Jr.; and Yeats, K.. “Is Banking Different? A Re-Examination of the Case for Regulation.” CATO Journal, 13 (1994), 345358.
Clarke, G.; Cull, R.; Peria, M. S. M.; and Sanchez, S.. “Foreign Bank Entry: Experience, Implications for Developing Economies, and Agenda for Further Research.” World Bank Research Observer, 18 (2003), 2559.
Collins, J.; Shackelford, D.; and Wahlen, J.. “Bank Differences in the Coordination of Regulatory Capital, Earnings, and Taxes.” Journal of Accounting Research, 33 (1995), 263291.
Comptroller of the Currency. Allowance for Loan and Lease Losses: Comptroller’s Handbook, Procedures. (1998).
Darrough, M.Disclosure Policy and Competition: Cournot vs. Bertrand.” Accounting Review, 68 (1993), 534561.
Darrough, M., and Stoughton, N.. “Financial Disclosure Policy in an Entry Game.” Journal of Accounting and Economics, 12 (1990), 219243.
Djankov, S.; La Porta, R.; Lopez-de-Silanes, F.; and Shleifer, A.. “The Regulation of Entry.” Quarterly Journal of Economics, 117 (2002), 137.
Dell’Ariccia, G.; Friedman, E.; and Marquez, R.. “Adverse Selection as a Barrier to Entry in the Banking Industry.” Rand Journal of Economics, 30 (1999), 515534.
Dell’Ariccia, G., and Marquez, R.. “Information and Bank Credit Allocation.” Journal of Financial Economics, 72 (2004), 185214.
Dell’Ariccia, G., and Marquez, R.. “Lending Booms and Lending Standards.” Journal of Finance, 61 (2006), 25112546.
Dell’Ariccia, G., and Marquez, R.. “Can Cost Increases Increase Competition? Asymmetric Information and Equilibrium Prices.” RAND Journal of Economics, 39 (2008), 144162.
DeYoung, R.; Hasan, I.; and Kirchhoff, B.. “The Impact of Out-of-State Entry on the Cost Efficiency of Local Commercial Banks.” Journal of Economics and Business, 50 (1998), 191203.
Dick, A.Nationwide Branching and Its Impact on Market Structure, Quality, and Bank Performance.” Journal of Business, 79 (2006), 567592.
Economides, N.; Hubbard, G.; and Palia, D.. “The Political Economy of Branching Restrictions and Deposit Insurance: A Model of Monopolistic Competition among Small and Large Banks.” Journal of Law and Economics, 39 (1996), 667704.
Fischer, P., and Verrecchia, R. R.. “Reporting Bias.” Accounting Review, 75 (2000), 229245.
Fox, W.Tax Structure and the Location of Economic Activity along State Borders.” National Tax Journal, 39 (1986), 387401.
Gambera, M.“Simple Forecasts of Bank Loan Quality in the Business Cycle.” Working Paper, Federal Reserve Bank of Chicago (2000).
Garmaise, M., and Moskowitz, T.. “Bank Mergers and Crime: The Real and Social Effects of Credit Market Competition.” Journal of Finance, 61 (2006), 495538.
Gilbert, R., and Kochin, L.. “Local Economic Effects of Bank Failures.” Journal of Financial Services Research, 3 (1989), 333345.
Gilbert, R., and Vives, X.. “Entry Deterrence and the Free Rider Problem.” Review of Economic Studies, 53 (1986), 7183.
Giroud, X., and Mueller, H.. “Does Corporate Governance Matter in Competitive Industries?” Journal of Financial Economics, 95 (2010), 312331.
Golembe, C. H.History Offers Some Clues on Significance of Interstate Branching.” Banking Policy Report, 13 (1994), 44.
Gormley, T.; Kim, B.; and Martin, X.. “Do Firms Adjust Their Timely Loss Recognition in Response to Changes in the Banking Industry?” Journal of Accounting Research, 50 (2012), 159196.
Gorton, G., and He, P.. “Bank Credit Cycles.” Review of Economic Studies, 75 (2008), 11811214.
Harris, M. S.The Association between Competition and Managers’ Business Segment Reporting Decisions.” Journal of Accounting Research, 36 (1998), 111128.
Henderson, C.The Economic Performance of African-American-Owned Banks: The Role of Loan Loss Provisions.” American Economic Review Papers and Proceedings, 89 (1999), 372376.
Holmes, T.The Effect of State Policies on the Location of Manufacturing: Evidence from State Borders.” Journal of Political Economy, 106 (1998), 667705.
Hryckiewicz, A., and Kowalewski, O.. “Economic Determinants and Entry Modes of Foreign Banks into Central Europe.” Working Paper, Goethe University Frankfurt (2008).
Huang, R.Evaluating the Real Effect of Bank Branching Deregulation: Comparing Contiguous Counties across US State Borders.” Journal of Financial Economics, 87 (2008), 678705.
Huber, G., and Arceneaux, K.. “Identifying the Persuasive Effects of Presidential Advertising.” American Journal of Political Science, 51 (2007), 957977.
Huizinga, H., and Laeven, L.. “Bank Valuation and Accounting Discretion during a Financial Crisis.” Journal of Financial Economics, 106 (2012), 614634.
Hutnyan, J.States Start Considering Whether or When to Opt for Interstate Branching.” Banking Policy Report, 14 (1995), 77.
Jayaratne, J., and Strahan, P.. “The Finance-Growth Nexus: Evidence from Bank Branch Deregulation.” Quarterly Journal of Economics, 111 (1996), 639670.
Jayaratne, J., and Strahan, P.. “Entry Restrictions, Industry Evolution and Dynamic Efficiency: Evidence from Commercial Banking.” Journal of Law and Economics, 41 (1998), 239274.
Jiang, L.; Levine, R.; and Lin, C.. “Competition and Bank Opacity.” Review of Financial Studies, 29 (2016), 19111942.
Johnson, C., and Rice, T.. “Assessing a Decade of Interstate Bank Branching.” Washington and Lee Law Review, 65 (2008), 73127.
Kanagaretnam, K.; Lobo, G.; and Yang, D.. “Joint Tests of Signaling and Income Smoothing through Bank Loan Loss Provisions.” Contemporary Accounting Research, 21 (2004), 843884.
Keele, L., and Titiunik, R.. “Geography as a Causal Variable.” Working Paper, University of Michigan (2012).
Kilic, E; Lobo, G.; Ranasinghe, T.; and Sivaramakrishnan, S.. “The Impact of SFAS 133 on Income Smoothing by Banks through Loan Loss Provisions.” Accounting Review, 88 (2013), 233260.
Kim, M., and Kross, W.. “The Impact of the 1989 Change in Bank Capital Standards on Loan Loss Provisions and Loan Write-Offs.” Journal of Accounting and Economics, 25 (1998), 6999.
Koetter, M.; Kolari, J.; and Spierdijk, L.. “Enjoying the Quiet Life under Deregulation? Evidence from Adjusted Lerner Indices from U.S. Banks.” Review of Economics and Statistics, 94 (2012), 462480.
Kroszner, R., and Strahan, P.. “What Drives Deregulation? Economics and Politics of the Relaxation of Bank Branching Restrictions.” Quarterly Journal of Economics, 114 (1999), 14371467.
Li, X.The Impact of Product Market Competition on the Quantity and Quality of Voluntary Disclosures.” Review of Accounting Studies, 15 (2010), 663711.
Liu, C., and Ryan, S.. “Income Smoothing over the Business Cycle: Changes in Banks’ Coordinated Management of Provisions for Loan Losses and Loan Charge-Offs from the Pre-1990 Bust to the 1990s Boom.” Accounting Review, 81 (2006), 421441.
Marquez, R.Competition, Adverse Selection, and Information Dispersion in the Banking Industry.” Review of Financial Studies, 15 (2002), 901926.
Milgrom, P., and Roberts, J.. “Limit Pricing and Entry under Incomplete Information: An Equilibrium Analysis.” Econometrica, 50 (1982), 443459.
Moyer, S.Capital Adequacy Ratio Regulations and Accounting Choices in Commercial Banks.” Journal of Accounting and Economics, 13 (1990), 123154.
Nichols, D.; Wahlen, J.; and Wieland, M.. “Publicly Traded versus Privately Held: Implications for Conditional Conservatism in Bank Accounting.” Review of Accounting Studies, 14 (2009), 88122.
Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, and Office of Thrift Supervision. Interagency Policy Statement on the Allowance for Loan and Lease Losses. (2006).
Olson, M. The Logic of Collective Action: Public Goods and the Theory of Groups. Cambridge, MA: Harvard University Press (1965).
Petersen, M., and Rajan, R.. “Does Distance Still Matter? The Information Revolution in Small Business Lending.” Journal of Finance, 57 (2002), 25332570.
Prager, R., and Hannan, T.. “Do Substantial Horizontal Mergers Generate Significant Price Effects? Evidence from the Banking Industry.” Journal of Industrial Economics, 46 (1998), 433452.
Redlich, F. The Molding of American Banking: Men and Ideas, Part II, 1840–1920. New York, NY: Hafner (1951).
Rhoades, S. Bank Mergers and Banking Structure in the US, 1980–1998. Washington: Board of Governors Staff Study 174, Board of Governors of the Federal Reserve System (2000).
Rice, T., and Strahan, P.. “Does Credit Competition Affect Small-Firm Finance?” Journal of Finance, 65 (2010), 861889.
Ryan, S. G. Financial Instruments and Institutions: Accounting and Disclosure Rules. 2nd ed. Hoboken, NJ: John Wiley & Sons (2007).
Ryan, S. P.The Costs of Environmental Regulation in a Concentrated Industry.” Econometrica, 80 (2012), 10191061.
Strahan, P.The Real Effects of U.S. Banking Deregulation.” Federal Reserve Bank of St. Louis Review, 85 (2003), 111128.
Sylla, R.; Legler, J.; and Wallis, J.. “Banks and State Public Finance in the New Republic: The United States, 1790–1860.” Journal of Economic History, 47 (1987), 391403.
Verrecchia, R.Endogenous Proprietary Costs through Firm Interdependence.” Journal of Accounting and Economics, 12 (1990), 245250.
Verrecchia, R.Essays on Disclosure.” Journal of Accounting and Economics, 32 (2001), 97180.
Wahlen, J.The Nature of Information in Commercial Bank Loan Loss Disclosures.” Accounting Review, 69 (1994), 455478.
Zarutskie, R.Evidence on the Effects of Bank Competition on Firm Borrowing and Investment.” Journal of Financial Economics, 81 (2006), 503537.
Zou, Y.“Strategic Entry Decisions, Accounting Signals, and Risk Management.” Working Paper, George Washington University (2018).
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Journal of Financial and Quantitative Analysis
  • ISSN: 0022-1090
  • EISSN: 1756-6916
  • URL: /core/journals/journal-of-financial-and-quantitative-analysis
Please enter your name
Please enter a valid email address
Who would you like to send this to? *
×

Metrics

Full text views

Total number of HTML views: 0
Total number of PDF views: 31 *
Loading metrics...

Abstract views

Total abstract views: 193 *
Loading metrics...

* Views captured on Cambridge Core between 4th April 2018 - 19th April 2018. This data will be updated every 24 hours.