Bank loan-loss provisions and the income-smoothing hypothesis: An empirical analysis, 1976–1984 (original) (raw)
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Determinants of bank income smoothing using loan loss provisions in the United Kingdom
2022
This paper investigates the determinants of bank income smoothing using loan loss provisions in the United Kingdom from 1999 to 2017. The findings show that UK banks use loan loss provisions for income smoothing purposes. Income smoothing is greater in times of high economic policy uncertainty. The extent of bank income smoothing is reduced by foreign bank presence, UK GAAP adoption, IFRS9 adoption, and high levels of voice and accountability. Also, there is reduced income smoothing using loan loss provisions during a financial crisis and in periods of economic prosperity. The implication is that economic conditions, institutional governance and accounting disclosure rules influence the extent of bank income smoothing in the United Kingdom. The findings of the study contribute to several studies that explore the determinants of bank income smoothing in a single country context.
Cross-country determinants of bank income smoothing by managing loan-loss provisions
Journal of Banking & Finance, 2008
This paper studies the determinants of income smoothing by management of loan-loss provisions in banks around the world. Using a panel database of 3,221 bank-year observations from 40 countries and controlling for unobservable bank effects and for the endogeneity of explanatory variables, we find that bank income smoothing depends on investor protection, disclosure, regulation and supervision, financial structure, and financial development. Results suggest there is less bank income smoothing not only with the strength of investor protection, but also with the extent of accounting disclosure, restrictions on bank activities, and official and private supervision, while there is more income smoothing with market orientation and development of a country's financial system.
Discretionary Loan-Loss Provision Behavior in the US Banking Industry
SSRN Electronic Journal, 2018
Earnings management can be either opportunistic, adding noise to reported earnings, or informative about a firm's underlying economic performance, adding valuable information to financial reports. This study examines earnings management in banks with differing levels of information asymmetry. Specifically, we compare earnings management between public and private banks by using discretionary loan-loss provisions (DLLPs) as proxies. Employing a large dataset of US public and private banks from 1986:Q1 to 2013:Q4, this study provides evidence of stronger earnings management behavior in public banks versus private banks. The evidence remains robust under a battery of sensitivity tests. Since incentives for earnings management are more relevant within a specific context, we identify the conditions that motivate different earnings management incentives, which allows us to better observe specific managerial motives. Greater DLLPs observed in public banks are utilized to send private information to investors, consistent with the signaling hypothesis. We also find evidence that capital requirements alter DLLPs, consistent with the capital management hypothesis. Banks with relatively low (high) earnings tend to decrease (increase) their earnings through manipulation of DLLPs, inconsistent with our income-smoothing hypothesis. The study extends to current debates on earnings management between public and private firms, and also provides a better understanding of the determinants of earnings management.
Income smoothing through loan loss provisions in south and Eastern European banks
Zbornik radova Ekonomskog fakulteta u Rijeci: časopis za ekonomsku teoriju i praksu/Proceedings of Rijeka Faculty of Economics: Journal of Economics and Business
This study provides empirical evidence on income smoothing from the banking sector in nine SouthEastern Europe (SEE) countries for the period 2005-2014 by applying a number of methodological approaches. First, by using a sample of 321 banks this paper confirms our first hypothesis that banks in the SEE region use loan loss provisions (LLPs) to smooth their incomes. Second, by dividing the loan loss provision into its two components (discretionary and non-discretionary,) the study provides new evidence on the effects of loan loss provisions components on growth in bank lending. The results clearly prove our second hypothesis that the components of LLPs do matter on growth in bank lending. Third, this paper estimates the use of loan loss provisions for capital management by banks. The empirical results do not support the hypothesis of capital management for SEE banks. The novelty of this paper, unlike other works, is the inclusion of SEE countries.
Loan Loss Provisioning of the U.S. Commercial Banks after the Financial Crisis
Universal Journal of Accounting and Finance, 2019
As bank managers have informational advantage in screening and monitoring borrowers, loan loss provisions determined by bank managers may contain important information for outside investors and regulators. This paper adapts a time-series framework and finds that loan loss provision contains information for future non-performing loans during the post-crisis period. This indicates that U.S. commercial banks have been associated with enhanced risk-taking discipline [Bushman and Williams, 2012]. Secondly, high yield corporate bond spreads have contained information for future bad loans, and loan loss provisioning by bank managers has incorporated such information. Finally, when exercising the discretion of loan loss provisioning by bank managers, smoothing the long-run level of loan loss reserves has been considered. Traditional hypotheses such as earnings management, capital management or income signaling are not supported by the data.
2014
This paper used results of panel least squares regression model to study on income smoothing behaviour through loan loss provisions of commercial banks in Malaysia during the Asian finance and banking crisis covering from the Asian currency crisis 1997, the United States sub-prime crisis 2009, and the current Euro debt crisis. Income smoothing behaviour is defined as behaviour that earnings do not dip or rise according to actual performance, and thus shows little fluctuations. The findings showed the banks in Malaysia did not smooth their income through loan loss provisions. Some possible explanations were good governance with stringent conditions imposed by regulators instead of market discipline.
Loan Loss Provisioning of US Banks: Economic Policy Uncertainty and Discretionary Behavior
SSRN Electronic Journal
This paper examines the effect of economic policy uncertainty (EPU) on loan loss provisions (LLP). Using a sample of 6,384 US banks and yearly data from 2009-2019, the findings reveal that in times of higher economic policy uncertainty, banks tend to increase their loan loss provisioning. Considering the four components of EPU (the news-based, tax expirations, consumer price index forecast disagreement, and government purchases forecast disagreement), the findings document that the majority of the explanatory power on loan loss provisions originates from news-based and tax expiration indices. Moreover, US banks discretionally use loan loss provisions in normal times, especially for capital management and income smoothing. Considering the possible interaction of such discretionary behavior with EPU, we observe that US banks use provisions for income smoothing rather than for capital management during such uncertain times, and loan loss accruals are exacerbated through income smoothing under uncertainty. Additional analysis indicates that private banks conduct more income smoothing through provisions in uncertain times as compared to listed banks. The findings of the study highlight EPU as an additional procyclical factor to influence bank LLP behavior and offer some relevant policy implications.
Journal of Finance and Bank Management , 2015
Banking industry is one of the most profitable industries in Sri Lanka and lending operations constitute as the core banking business which is a highly risk area. As a tool to mitigate the credit risk that occurs in the banking business it involves in providing for loan losses which ultimately affect the profitability of the bank. This study therefore attempts to ascertain whether Sri Lankan Commercial banks use loan loss provisions to smooth their income. The time period considered for the study is 2003 to 2012 with a balanced set of panel data. Eight bank specific variables were used which are; capital adequacy ratio, change in total loans, change in non-performing loans, total loans, non-performing loans, earnings before tax and provisions, loans to deposit ratio and log value of total assets. First the whole sample was examined and later analysis was done to three major categories namely; public sector banks, systematically important private banks and small private banks. The findings reveal that private domestic licensed commercial banks use loan loss provisions to smooth the income while the public sector banks are not. Loan loss provisions of banks to a large extent is depend on four bank specific variables. It was further revealed that banks with high level of loan growth are associated with a reduced level of problem loans. Finally the study suggests important policy implications for bankers and regulators that might help to address income smoothing activities of financial sector in Sri Lanka.
Management of Financial Services: Creating Business Value and Sustainability, 2018
Purpose: The banking system being the backbone of the economy is found to indulge in income smoothing. The functioning of financial institutions is different from that of other industries which is why corporate governance of bank a crucial issue. If any other organisation falters, it has limited impact on only its stakeholders, but if a financial institution falters, the repercussions are on the entire economy. Thus the basic research question of the study is "do banks use loss loan provisions to indulge in earning management and what impact do these provisions have on earnings management?' Prior Literature: Across different countries, it has been found that Loss Loan Provisions is not only used as means of earnings management in the long run but has an effect on the quality of loans and efficiency of the operations (Ma, 1988). As a result, it may lead to failure of the banking system. Research methodology: The data for a period of eleven years from 2007-2017 was collected for a sample of 37 commercial banks (26 PSUs and 11 Private Banks). The panel data has been subject to unit root test to check the stationarity of the data. To understand the long term impact the Toda & Yamamoto 1995 test has been applied with Johnsen Cointegration Test for checking the robustness of the equation. Findings: The estimates of Block ExogeneityWald test shows chi-square distribution with 5 degrees of freedom (Lag Length=8) and the corresponding Probability. In the above-given table, the probability of all the independent variables is more than 0.05. As a result, we accept the null hypothesis that Loss Loan Provisions has a significant positive relation with Earning before Taxes and Provisions, Non-Performing Assets, Total Loan and advance and Capital Adequacy Ratio of the banks. Thus, the banks use LLPs as a tool for earnings management Suggestions: Banks may also smooth the earnings in order to meet the regulatory requirement. While the problem of provision has clearly been expressed in studies conducted both in India and other countries, yet a forward-looking approach that focuses on the borrowing capacity and creditability of the loan payer rather than changing the provisioning policies is required. Original contribution: There have been several studies on banks regarding the credit risk but very few studies have been conducted on earnings management in India. With different time-period taken into consideration, the results also vary.
Do Dynamic Provisions Reduce Income Smoothing Using Loan Loss Provisions?
SSRN Electronic Journal, 2011
Spanish banks had to set aside a countercyclical loan loss provision during the period 2000-2004. The amount of such provision as well as the allowance accumulated had to be disclosed by banks. The former creates a natural experiment to test whether banks smooth earnings to mislead investors and other interested parties, or, by contrast, income smoothing is used to avoid the existence of market frictions. Using panel data econometric techniques, we find evidence of income smoothing through loan loss provisions during the period previous to the implementation of the countercyclical provision (1988-1999). However, during 2000-2004, banks relied only on the newly created countercyclical provision to smooth income. This change in behaviour suggests that there may be efficiency gains in reducing the volatility of accounting earnings over time.