ARTICLE IN PRESS JID: RACREG [m5G;November 16, 2017;19:44] Research in Accounting Regulation 000 (2017) 1–10 Contents lists available at ScienceDirect Research in Accounting Regulation journal homepage: www.elsevier.com/locate/racreg Regular paper Too big to fail and bank loan accounting in developing nations: Evidence from the Mexican financial crisis Alejandro Hazera * , Carmen Quirvan , Anis Triki University of Rhode Island, USA a r t i c l e i n f o Article history: Available online xxx Keywords: Too big to fail Financial crisis Mexico Bank loan accounting a b s t r a c t During the 1990s and early 2000s, developing nations in all parts of the world experienced financial crisis. Studies have documented, both theoretically and empirically, that authorities’ guarantee that in- solvent financial institutions would be “bailed out” increased the incentives of banks, especially large institutions, to take on excessive loan risk. However, little research has been conducted on how the pos- sibility of being “bailed out” impacts banks’ decisions regarding the understatement of loan loss reserves (i.e. the tendency to conceal loan risk). We argue that the Mexican financial crisis of the 1990s repre- sents a rich setting to investigate the link between “bailout assistance” and banks’ accounting for loan loss reserves. The analysis of loan trends for the entire financial system shows that Mexican banks fully reserved non-performing loans not in 1997, when new accounting standards took effect, but rather in 1999–2001, after the largest institutions had been sold to foreign banks and international bailout as- sistance had been exhausted. Also, the results show that in the period preceding their sale to foreign institutions, “Too Big To Fail” (TBTF) banks used bailout assistance to directly manage their reserves. By contrast smaller banks used non-bailout sources of capital to reserve non-performing consumer loans, and directly swapped non-performing commercial loans for bailout assistance. Thus, while both TBTF and smaller banks utilized bailout assistance, the bailout funds only affected loan loss reserve levels in the case of TBTF banks. © 2017 Elsevier Ltd. All rights reserved. 1. Introduction 1.1. The Process of Crises In the late twentieth century, the increasingly rapid globaliza- tion of capital flows contributed to the spread of financial crises in many developing countries. These included: the Mexican finan- cial crisis of 1994/1995 (Camdessus, 1995); the East Asia crisis of the late 1990s (Thailand, Indonesia, the Philippines, and South Ko- rea) (Walter, 2008); the 1998 Russia crisis (Pinto & Unalov, 1998); and later crises in some South American countries (Argentina 2001, Ecuador, 1999). While each of these crises had different origins, many followed a similar chronological pattern. The discussion be- low uses Mishkin’s (Mishkin 1999, 2006) chronological order to ex- plain the process of financial crises. First, many of the crises were preceded by financial and economic liberalization programs which opened the nations’ economies to for- eign trade and investment (Mishkin, 1999, 2006). These included: * Corresponding author. E-mail addresses: sofborder@uri.edu (A. Hazera), cquirvan@uri.edu (C. Quirvan), Trikianis@uri.edu (A. Triki). Mexico’s 1994 entrance into the North American Free Trade Agree- ment (NAFTA) and foreign investment liberalization; trade and fi- nancial liberalization programs by East Asian nations in the mid- 1990s (Walter, 2008); and late 1990s economic liberalizations by South American countries (e.g. Argentina, Bolivia, and Ecuador) which followed the policies advocated by the Washington Consen- sus. 1 Second, in many cases, “regulatory gaps” emerged as the coun- tries’ economic and financial liberalizations were not accompanied by adequate financial regulatory reforms, including improvements to bank accounting. For example, during Mexico’s early 1990s economic and financial liberalization, no new regulations were passed to govern rapid flows of foreign portfolio investment or to improve bank supervision, operations, and accounting (e.g. risk management systems, internal audit departments, loan origination practices, and loan accounting) (Hazera, 1999; McQuerry, 1999; Desmet, 2000; Musacchio, 2012). A similar lack of (1990s) reforms preceded the crisis in several of the Asian nations (including, 1 The Washington Consensus was a group of Washington D.C. based economists who advocated that sudden economic liberalization by developing nations would provide those countries with fast economic growth and development (Williamson, 1990, 2004). https://doi.org/10.1016/j.racreg.2017.09.002 1052-0457/© 2017 Elsevier Ltd. All rights reserved. Please cite this article as: A. Hazera et al., Too big to fail and bank loan accounting in developing nations: Evidence from the Mexican financial crisis, Research in Accounting Regulation (2017), https://doi.org/10.1016/j.racreg.2017.09.002