Does State‐Level Economic Policy Uncertainty Affect Financial Distress Risk of Financial Institutions?

ABSTRACT Using a sample of US banks, we examine the effects of state‐level economic policy uncertainties (EPUs) on banks' distress risk. Our results suggest that state‐level EPUs positively affect the distress risk. The findings are consistent with the alternative measures of distress risk. We document that the discretionary use of loan loss provisions (opacity), as not explicitly disclosed in the formal managerial communication for shareholders, exacerbates the effects of state EPUs on distress risk and does not help the bank's stability. Further, the effects of state‐EPUs increase as the size becomes larger, and diversified and regional banks are the most susceptible.