Do delays in expected loss recognition affect banks' willingness to lend?

Banks can decrease their future capital inadequacy concerns by reducing lending. The capital crunch theory predicts that lending is particularly sensitive to regulatory capital constraints during recessions, when regulatory capital declines and external-financing frictions increase. Regulators and policy makers argue that the current loan loss provisioning rules magnify this pro-cyclicality. Exploiting variation in the delay in expected loss recognition under the current incurred loss model, we find that reductions in lending during recessionary relative to expansionary periods are lower for banks that delay less. We also find that smaller delays reduce the recessionary capital crunch effect. These results hold across management quality partitions. ► We study how loss recognition delays and capital requirements affect bank lending. ► Banks with greater delays are more pro-cyclical due to reduced recessionary lending. ► Banks with smaller delays increase their non-recessionary pre-provision equity more. ► We do not find capital ratio induced pro-cyclicality prior to capital regulation. ► Large banks are more vulnerable to capital constraints post-FDICIA/Basel.