Purpose: The purpose of this paper is to investigate whether the level of bad debt provisions of financial institutions is affected by internal governance mechanisms (IGMs) from the perspective of the Type II principal-principal (PP) conflicts between the controlling shareholders and the minority shareholders. Design/methodology/approach: The authors' sample covers all listed financial institutions in China, comprising a panel data set of 139 firm-year observations covering 1999 to 2009. Within China's two-tier corporate governance context, the three IGMs - ownership structure, board of directors and supervisory board - are measured to examine the level of bad debt provisions. Findings: The findings suggest that state ownership and legal person ownership are negatively related to the level of bad debt provisions, but board size reveals a positive association. Other factors including foreign ownership, independent directors, board meeting, supervisory board size and supervisory board meeting were found to have no impact. Practical implications: The spirit of corporate governance reform has not been transferred to financial institutions sufficiently. The board of directors and supervisory board actually act the roles of "window dressing" or "rubber stamp" within the current two-tier system. From the Type II PP perspective, the controlling shareholders are found to moderate the conflicts between other parties but they still expropriate the interests of minority shareholders and are the real beneficiaries of recent reforms. Thus, further financial reforms seem necessary in China. Originality/value: The paper provides an empirical analysis of factors that underlie IGMs during an important period of regulatory change and organizational reform, and fills a literature gap concerning the effectiveness and efficiency of financial institutions. © Emerald Group Publishing Limited.