Bank Taxation and Loan Charge-offs

    Project: Research project

    Project Details


    In this proposed research, we investigate the effect of corporate tax incentives on bank financial reporting choices. Specifically, we propose to examine the effects of changes in bank income tax rates on the timeliness of bank loan charge-offs. Timely write-off of delinquent loans allows banks to maintain a healthy balance sheet and enables investors to better assess bank risk and uncertainties. However, the decision to charge-off delinquent loan involves considerable judgement and discretion, and verification is costly to regulators. Despite the regulatory guidelines and the tax rules that align the timing of loan charge-offs with regulatory objectives, both anecdotal evidence and academic research suggests that banks do not appear to adhere to the regulatory guidelines and write-off bad loan on a timely manner (Liu and Ryan 2006).

    In light of bank regulators’ concern about banks do not charge off delinquent loans on a timely manner, a natural question to ask is how policy can be designed to improve the timeliness of charge-offs. In addition to generating fiscal revenue, tax policies are often used by governments to induce taxpayer behavior, such as effort, spending, and innovation. In this proposed research, we examine a potential benefit of aligning the tax deductibility of loan losses with loan charge-offs to improve the timeliness of loan charge-offs. To study our research question, we develop an empirical framework to measure loan charge-off timeliness, an area that received little attention from prior research. To our understanding, our proposed research is the first to empirically measure the timeliness of loan charge-offs. In addition to our main research question, we are interested in the potential moderating effects of the incentives of two important stakeholders of banks: the IRS and bank regulators. Considering the opposing incentives of the two regulators, our second and third research questions focus on the two cross- sectional predictions: (i) the effect of state tax rate increases on accelerating charge- offs is more pronounced when the bank is subject to low enforcement level from the IRS, who have an incentive to deter overstating charge-offs for tax deduction purposes, and (ii) the effect of state tax rate decreases on delaying charge-offs is more pronounced when banks are subject to more lenient regulation. These cross-sectional analyses enhance the identification of a tax effect and highlight the significance of regulators in affecting banks’ response to tax incentives.
    Effective start/end date1/01/23 → …


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