Do Political Connections Affect Bank Loan Loss Provision Reliability?

Abstract

This study examines whether political connections affect the loan loss provision (LLP) quality of financial institutions, in particular LLP reliability. Using a geography-based measure, I document that politically connected banks have more reliable LLP than do non-connected banks, consistent with the fact that politically connected banks are subject to more extensive controls than non-politically connected banks.  Thus, political connections are more likely to be associated with reliable LLP. In addition, I document that the effect of improved political connections on reliability is more pronounced in the subsamples of banks with investment grades relative to the subsamples of banks with noninvestment grades. Finally, the effect of political connections on reliability is more pronounced in the subsample of banks in the expansion periods relative to the recession periods. These findings are consistent with the argument that connected banks did not engage in improving LLP quality for predicting future loan defaults as they might have relied on receiving support from the government in lieu of expending their resources.