The Effect of Fiscal Policy on Banks' Financial Reporting

Abstract

This dissertation documents the effect of governments' fiscal policy on banks' loan loss provisions. Governments' deficits are inversely related to the credibility and strength of implicit guarantees granted to the banking sector, affecting the tail risk properties of banks' loan portfolios. I predict and find a positive relation between governments' deficits and banks' loan loss provisions. The fiscal effect is statistically and economically stronger than the relationship between business cycles and banks' loan loss provisions, and is moderated by the country's debt-to-GDP ratio. My results are robust to different sample partitions and after controlling for potentially confounding effects. To address endogeneity concerns between fiscal policy, business cycles, and banks' financial reporting decisions, I identify fiscal shocks by estimating innovations to governments' military expenditures. Results from an instrumental variables approach support the association between fiscal shocks and banks' loan loss provisions. Taken together, my results shed light on how fiscal policy decisions affect banks' financial reporting choices.