The Signalling Effects of Bank Loan-loss Reserve Additions

This study examines the market’s reaction to announcements of additions to the Loan Loss Reserve (LLR) account resulting from diverse problems in a bank’s loan portfolio which are unrelated to an international debt crisis. For the overall sample, with no division by type of loan, the reaction to an increase in LLRs is negative and statistically significant before the announcement; however, it turns positive and remains statistically significant for several days afterwards. Viewing each category individually, the results vary. The largest statistically significant results are for Lesser Developed Country Loans and Foreign and Domestic Loans (positive reaction) and combination Real Estate and Energy Loans (negative reaction). A division of the data into two sub-samples, before and after 1987, indicates that investors appear to be more discerning of individual BHCs’ circumstances surrounding announcements after 1987.