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we're here today with Wharton accounting professor Allison Nicoletti to talk
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about her latest research Allison thanks for being here thanks for having me so you're going to talk to us today a
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little bit about your dissertation so first of all could you give us kind of a broad overview of what you looked at
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sure so my dissertation examines how external auditors and bank regulators affect Lomas provision decisions
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so the Lomas provision it's analogous to bad debt expense for a non financial
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firm and for banks it's one of the most important accruals it makes up a large
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part of their income statement and then also it has implications because it's
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tied to their loan quality so this is a really important decision that banks care about and also that the bank
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regulators and external auditors are concerned with and there's a lot of discretion that goes into coming up with
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the Lomas provision estimate so what's interesting is that bank regulators are
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involved in on-site safety and soundness examinations and external auditors come
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in and actually audit the financial statements but these two groups have very different objectives and incentives
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where bank regulators are coming at it more from the safety and soundness for SEC perspective whereas auditors are
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coming at it from a do the financial statements comply with generally accepted accounting principles so what I
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find in my paper is that bank regulators and auditors both seem to increase the timing with which banks recognize loan
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losses but at banks where there's both a strict regulator and an external auditor
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these banks are actually less timely compared to banks that are unaudited but have a strict regulator so what this
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seems to suggest is that the auditor is constraining timeliness relative to what
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the bank regulator would prefer and this is again probably tied to the objectives
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and incentives that they have where auditors are concerned about earnings management and other discretionary
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choices that banks might be making that aren't necessarily tied to loan quality
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whereas the regulator is less concerned with that so what is the implications there for first of all for a bank or for
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even is there implications for like a customer who's coming in to get a loan
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well there's definitely implications for the bank because the bank manager is
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trying to balance these two potentially opposing viewpoints so we have bank regulators who are pushing more
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timeliness versus the auditor who maybe prefers less timeliness relative to the regulator so that's one of the takeaways
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is that bank managers do have to balance that but more importantly is that Lomas
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Accounting Standards are actually changing and this was the direct result of the financial crisis so one of the
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concerns with the current rules is that auditors are concerned about the discretion that banks have and that was
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why they restricted is that they're concerned that banks are managing earnings or doing other opportunistic
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things with the accounting this was all this was a problem of in the financial crisis because the threshold to
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recognize the loss was very high so we saw banks waiting quite a bit of time before they recognized any losses so the
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new accounting standards will be more of an expected approach so banks will be recognizing losses over the life of the
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loan but there's going to be a lot more discretion that goes into that so as far
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as how this regulator auditor conflict its resolved or actually gets worse under the new accounting standards is an
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open question now are there any implications for just the average person who's trying to get a loan or even a
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business trying to get a loan or is this more on the bank side well there could be some implications as far as the new
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accounting standards going into place so to the extent that banks are going to have to recognize greater loan losses
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that has to hit somewhere on their balance sheet so if it's coming out of their capital and there's bank capital
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requirements so that may actually result in restricting lending purposes so it could have an effect like that
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my research probably can't speak to that quite as much just because I'm looking
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at a different accounting standard but it does really just more speak to the bank managers themselves and then
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probably regulators auditors and groups that are involved in overseeing the audit profession now is there with bank
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managers I mean has there been sort of an historical in terms of like whether they would serve trend towards what the
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regulator's are looking for versus auditors or vice versa and are there ProGlide guess prevailing winds on as
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far as that go there just does it depend on the bank or so I think it probably depends is the the short answer but
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there's been a lot of conflict between the regulator and auditor over the last
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20 or 25 years so in the late 1990s there was a conflict again between the regulators and auditors where it seemed
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that banks were trending more towards the regulator view where they were reserving to a great extent for loan
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losses even perhaps more than the economic of their loan portfolio would imply so
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the sec or so kind of a group that's more aligned probably with the external
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audit function was not happy about that because it was basically shifting income
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between reporting periods so there was a struggle between the bank regulators and
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the auditors or in the sec and what ended up happening was is that the bank regulators in the SEC issued new
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guidance saying this is what you should be doing for loan losses so actually the
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SEC ended up winning that battle but now following the crisis it seems that we're
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actually shifting more back to a standard that perhaps regulators would prefer so I think that we'll probably
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see Bank shifting more back to the regulator view but they were more in the audit SEC camp earlier in the decade and
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so what's next for this research what are you going to look at next so I have
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a different project that I'm going to be looking at that still related to bank
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regulation but it's looking at the dodd-frank act so what we're interested
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in this paper is looking at specific bright-line asset thresholds so many Bank regulations and other regulations
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in general but they have these thresholds like ten billion in total assets for instance we're above that
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threshold banks are subject to significant regulatory costs so what we're looking at is whether those
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bright-line thresholds seem to incentivize merger activity and if they do do these mergers and have different
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outcomes relative to other mergers so the preliminary findings of that would suggest that these thresholds do spur
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additional merger activity and at these mergers that result from these regulatory cost motivations do seem to
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end up having poor outcomes relative to other mergers great thank you so much for talking with us thing
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