Bank loan loss provisions and capital management under the basel accord

Abstract

This thesis examines capital management mechanisms of the U.S. banks under the Basel Accord. An important finding is that Tier I capital and Tier II capital management incentives and their associated manipulation mechanisms are significantly different. Banks are likely to decrease (instead of increasing) loan loss provisions for Tier I capital management. In contrast, banks increase loan loss provisions for Tier II capital management. This dichotomy in capital management is completely missed out in prior literature. This study further examines cross-sectional variations of identified capital management mechanisms across different banks. Consistent with evidences from non-banking industries, banks purchased substantial amount of nonaudit services are more likely to engage in capital manipulations. In contrast, consistent and regular purchases of nonaudit services (low variability) suppress manipulation actions. Lastly, capital management prevails in small banks.