Loan Loss Provisioning of US Banks : Economic Policy Uncertainty and Discretionary Behavior

This paper examines the effect of economic policy uncertainty (EPU) on loan loss provisions (LLP). Using a sample of 6,384 US banks and yearly data from 2009-2019, the findings reveal that in times of higher economic policy uncertainty, banks tend to increase their loan loss provisioning. Considering the four components of EPU (the news-based, tax expirations, consumer price index forecast disagreement, and government purchases forecast disagreement), the findings document that the majority of the explanatory power on loan loss provisions originates from news-based and tax expiration indices. Moreover, US banks discretionally use loan loss provisions in normal times, especially for capital management and income smoothing. Considering the possible interaction of such discretionary behavior with EPU, we observe that US banks use provisions for income smoothing rather than for capital management during such uncertain times, and loan loss accruals are exacerbated through income smoothing under uncertainty. Additional analysis indicates that private banks conduct more income smoothing through provisions in uncertain times as compared to listed banks. The findings of the study highlight EPU as an additional procyclical factor to influence bank LLP behavior and offer some relevant policy implications