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Fiscal Deficits, Bank Credit Risk, and Loan-Loss Provisions

Published online by Cambridge University Press:  30 June 2020

Felipe Bastos Gurgel Silva Open the ORCID record for Felipe Bastos Gurgel Silva [Opens in a new window]
Felipe Bastos Gurgel Silva*
Affiliation:
University of Missouri Trulaske College of [email protected]
*
[email protected]
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Abstract

Fiscal deficits represent an important variable for banks’ aggregate credit risk, revealing governments’ ability to curb banks’ losses in bad states, either with direct cash infusions or with macroeconomic stabilization policies. Deteriorating deficits are associated with increasing financial distress of the banking sector and higher levels of loan-loss provisions. The effect is more pronounced for banks with a strong aversion to underprovisioning and is robust to a battery of tests and to the identification of fiscal shocks using military-spending data. This association represents an additional source of negative comovement between provisions and economic conditions, with implications for financial stability.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 56 , Issue 5 , August 2021 , pp. 1537 - 1589
Copyright
© The Author(s), 2020. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

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Footnotes

This article is based on my PhD dissertation at Cornell University (all rights reserved). I am extremely grateful to my dissertation committee members: Robert Jarrow (co-chair), Sanjeev Bhojraj (co-chair), Warren Bailey, George Gao, and Kenneth Merkley for their encouragement and support throughout this project, as well as Donald van Deventer, Mark Mesler, and Martin Zorn from Kamakura Corporation for sharing the credit-risk data. Charles Oberweiser provided excellent research assistantship. This article also benefited from insightful comments and suggestions received from Aleksander Aleszczyk (discussant), Matt Baron, Rob Bloomfield, Murillo Campello, Gustavo Cortes, Igor Cunha, Manuela Dantas, Mike Durney, Jere Francis, Ryan Guggenmos, Umit Gurun, Jarrad Harford (the editor), Gaurav Kankanhalli, G. Andrew Karolyi, Inder Khurana, Dawoon Kim, Vladimir Kotomin (discussant), Bob Libby, Marcelo Moreira, Michael O’Doherty, Raynolde Pereira, Kristi Rennekamp, Raluca Roman (the referee), Mani Sethuraman, André Silva (discussant), Blake Steenhoven, and Stephen Zeff and workshop participants at Cornell University, Rice University, the University of Missouri, the University of Texas at Dallas, the 2019 Lubrafin Annual Meeting, the 2019 Financial Management Association (FMA) Annual Meeting, and the 2020 Midwest Finance Association Annual Meeting. I thank G. Andrew Karolyi, John Sedunov, and Alvaro Taboada for generously sharing their data on international bank flows, Sebastian Goerlich from the Bank for International Settlements (BIS) for clarifying important aspects of the CBS data, as well as George Gao, Xiaomeng Lu, and Zhaogang Song for courteously providing their data on rare disaster concerns. I also thank Jeandson Lopes, Paulo Machado, and three credit-risk-modeling analysts who wish to remain anonymous. An earlier version of this article has been circulated under the title “The Effects of Fiscal Policy on Banks’ Financial Reporting.” All errors are my own.

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