The Value Relevance of Loan Loss Provisions

This study examines the value relevance of loan loss provisions (LLP). Prior studies find that banks` discretionary LLP (DLLP) are perceived positively by the market and attribute this to greater LLP signaling to investors the soundness of the bank. However, these studies are based on data from the pre-Basel era when LLP increased Tier 1 capital and thus had positive implications. We focus on the post-Basel period in which LLP does not affect Tier 1 capital and apply a better specified model to test for the value relevance of loan loss provisions. We find that DLLP is not value relevant in the post-Basel period. This result is consistent throughout the recent financial crisis, which is contrary to Ryan`s (2011) conjecture that DLLP may be valued positively during economic downturn. In addition, LLP and nondiscretionary LLP (NLLP) are perceived negatively by the market. We also show that findings in the long-window value relevance test still hold in the short-window market reaction test. Overall, in the post-Basel period, DLLP provides no value relevant information whereas NLLP conveys value relevant information incremental to earnings.