Short-Selling Constraints and Bank Holding Companies’ Loss Recognition and Risk Taking

Accounting and Management Control

Speaker: Scott Liao

HEC Campus - Build.T - Room 017

Abstract:

While theories support short-selling bans on banks, we know little about the effect of short selling on banking activities empirically. In this paper, we examine whether and how changes in short-selling restrictions (i.e., Reg-SHO) affect bank loan loss provisions and risk taking. We find that pilot bank holding companies (BHCs) are more likely to delay loan loss recognition especially when they expect an increase in credit losses. We also find this delay in loss recognition to be concentrated in the sample of BHCs that are smaller and of lower regulatory capital, supporting the notion that these banks’ concerns over bank runs and regulatory pressure due to lower short-selling constraints lead BHCs to delay loss recognition. We further find that pilot BHCs that delay loan loss provisions are more likely to take on risky loans. In supplemental analyses, we find that while on average the equity market does react more negatively to pilot BHCs’ loan loss provisions, the equity market does not differentiate BHCs that delay loss recognition from those that do not. We also find that short sellers tend to short less on pilot BHCs that delay recognition of credit losses than BHCs that do not delay credit loss recognitions. Finally, we find that pilot BHCs that delay loss provisioning have higher crash risk in the recession period. Our study provides insights to the current debate on the role of short selling in the banking industry.