The use of discretionary loan loss provision by Islamic banks and conventional banks in the Middle East region: A comparative study (original) (raw)
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Studies in Economics and Finance, 2014
Purpose -The purpose of this paper is to study earnings management practices of Islamic banks and conventional banks in the Middle East region. First, the authors examine factors that may influence Islamic banks managers' use of discretion in reporting loan loss provisions (LLP). Second, the authors investigate differences that may exist between Islamic banks and non-Islamic banks in terms of discretionary loan loss provisions (DLLP) used to manipulate accounting earnings. Design/methodology/approach -This empirical study uses an unbalanced panel data of 21 Islamic banks, 18 conventional banks with Islamic windows and 33 conventional banks, from seven Middle East countries during a period that ranges from 2000 to 2008. The authors use a two-stage approach in order to examine factors that may influence the use of discretion by Islamic banks' managers. Findings -The empirical results reveal that Islamic banks use DLLP for both earnings and capital management. External financing is also found to be a determinant of DLLP. Additional findings show no significant differences among Islamic banks, conventional banks with Islamic windows and conventional banks in using DLLP. These three groups of banks behave similarly in terms of discretion based on DLLP. Practical implications -The findings are potentially useful for regulators, auditors and investors. This study provides regulators with insights to strengthen their financial regulations in order to improve accounting quality. In addition, it helps auditors when considering the provisioning policies adopted by banks in order to detect specific manipulations of accounting earnings. The results may also help investors to focus on the impact of managerial discretion on accounting earnings for evaluation purposes. Originality/value -This study contributes to the literature on Islamic banking. On the one hand, it extends prior research by examining the discretionary component of LLP, instead of being restricted to total LLP. On the other hand, it compares the use of discretion among three groups of banks: full Islamic banks, conventional banks with Islamic windows and full conventional banks.
How Islamic and Conventional Banks Use Discretionary Loan Loss Provision in Pakistan
Journal of Philosophy, Culture and Religion, 2020
The purpose of this paper is to investigate the use of DLLP in the banking sector of Pakistan. First, the study identifies the factors affecting the use of DLLP in Islamic banks of Pakistan. Secondly, the study also tries to examine the difference between the use of discretion in Islamic and conventional banks. The study used secondary data collection method and applied regression technique for analysis. The study provide evidence that all the factors including CAR, bank size and profitability effect the use of DLLP in Islamic banks except LD and EBTP. The study also found that conventional banks are more involved in DLLP compared with Islamic banks. The reason may be that Islamic banks in Pakistan work under Sharia supervisory board and avoid the practices of earnings management. The sharia principled are based on fairness, justice, and equal chances of profit and loss. This study may be helpful for regulators who can make policies for financial statements to be more transparent. This study can also be useful for investors to get to know how much discretion banks has made on the main accounting item.
Islamic Bank Incentives and Discretionary Loan Loss Provisions
papers.ssrn.com
The objective of this paper is to ascertain whether there are significant differences in the loan loss provisioning behaviour of Islamic banks as compared to conventional banks. We proposed that loan loss provisioning will be linked to the extent of profit distribution management. The results suggest that Islamic banks consistently record lower loan loss provisions. However, the association between profit distribution management and loan loss provisioning is mixed. The overall results tend to suggest that there is an inverse relationship between profit distribution management and loan loss provisions, which is contrary to the predicted association. The results also suggest that there are differential effects depending on whether the profit distribution management is for the benefit or the detriment of investment depositors. If there is a surplus of asset returns over profit distributions (positive profit distribution management), it is observed that Islamic banks increase their loan loss provisions in accordance with the prediction made in that study. However, this result does not extend to the full sample containing both Islamic and conventional banks. Further, there is no effect where the profit distribution management is for the benefit of investment depositors (i.e. where the Islamic bank decreases loan loss provisions when there is a deficiency of investment returns). 1 . I n t r o d u c t i o n A large array of theoretical and empirical literature has established that there are incentives for managers to smooth earnings and that they attempt to do so utilizing either their real or accounting discretion. Smooth earnings are widely cited as an indicator of earnings quality, partly attributed to its ability to mitigate firm-specific information risk (Francis, LeFond, Olsson and Schipper 2004). Smooth earnings also have special significance for banks. While investors in banks can diversify bank specific risk, idiosyncratic risk associated with the volatility of individual bank earnings cannot be diversified away by either bank managers and/or regulators. Such risks have potential systemic implications since the volatility of earnings (or significant losses) for one bank may cause a domino effect type system wide bank run. As a result, both bank managers and regulators have vested interests to ensure that earnings volatility is kept to a minimum for individual banks. To ensure that banks operate within the regulators tolerance levels, the regulators in most jurisdictions require monthly and quarterly reporting to monitor any potential unusual figures. To that extent, bank managers likely utilize both real and accounting choices to ensure that earnings demonstrate a smooth pattern. A large body of literature establishes the use of discretionary accounting choices such as loan loss provisions to manage bank earnings.
Loan-Loss Provisioning in the OIC Countries Evidence from Conventional and Islamic Banks
Using a sample of 291 banks from 35 OIC (Organization of Islamic Cooperation) member Muslim countries with 2078 bank year observations from 2003 to 2010, we analyze if bank earning management in terms of Loan Loss Provisioning (LLP hereafter) is affected by the banking nature whether Islamic or conventional, by the bank accounting standards whether rulebased local Generally accepted accounting principles (here after local GAAP) or principle-based
Loan Loss Provisioning in OIC Countries: Evidence from Conventional vs. Islamic Banks
Journal of King Abdulaziz University-Islamic Economics
Using a sample of 291 banks from 35 OIC (Organization of Islamic Cooperation) member Muslim countries with 2078 bank year observations from 2003 to 2010, we analyze if bank earning management in terms of Loan Loss Provisioning (LLP hereafter) is affected by the banking nature whether Islamic or conventional, by the bank accounting standards whether rulebased local Generally accepted accounting principles (here after local GAAP) or principle-based International Financial Reporting Standards (hereafter IFRS), and by the bank listing status. We argue that Islamic banks may exhibit lower signs of earning management, as the Sharia'h Supervisory Boards (SSB hereafter) in Islamic banks may work as an additional tier into the governance system. On the use of accounting standard, we argue that banks using IFRS standard may exhibit lower evidence of earning management, as IFRS requires managers to disclose more accounting information compared to local GAAP. We report mixed evidence supporting these arguments.
The Procyclicality of Loan Loss Provisions in Islamic Banks: Do Managerial Discretions Matter?
SSRN Electronic Journal, 2000
This paper is the first to examine whether the loan loss provisioning behavior of Islamic banks is procyclical. From a dynamic panel data methodology, the empirical results show that loan loss provisioning in Islamic banks is indeed procyclical, as higher economic growth leads to a decline in loan loss provisions. A closer investigation is also conducted to examine whether capital management, income smoothing, or signaling behavior can alter the procyclicality of loan loss provisions. Specifically, our results document that only capital management behavior can overcome the procyclicality of loan loss provisions. This paper therefore advocates the importance of strengthening discretionary behavior in Islamic banks in terms of capital management using loan loss provisions, particularly during economic boom.
The procyclicality of loan loss provisions in Islamic banks
Research in International Business and Finance, 2017
From a sample of Islamic banks around the world from 1997 to 2012, this paper examines whether loan loss provisioning in Islamic banks is procyclical. Our empirical findings highlight that loan loss provisioning in Islamic banks remains procyclical, although the „expected‟ loan loss model (E-LLM) has been implemented for Islamic banks in several countries. A closer investigation further documents that Islamic banks also use loan loss provisions for discretionary managerial actions, especially related to capital management in which loan loss reserves and provisions are inflated when bank capitalization declines. Eventually, this paper highlights that higher capitalization can mitigate the procyclicality of loan loss provisions in Islamic banks. In other words, loan loss provisioning becomes countercyclical for Islamic banks with higher capitalization. This paper therefore casts doubts on the adoption of the E-LLM for Islamic banks to promote countercyclical effects, because the E-LLM may be influenced by managerial discretion, including opportunistic capital management using loan loss provisions that may undermine the importance of maintaining sufficient bank capitalization.
Loan loss provisions and audit quality: Evidence from MENA Islamic and conventional banks
The Quarterly Review of Economics and Finance, 2020
This paper examines the impact of audit quality on earnings management through loan loss provisions among both conventional and Islamic banks operating in MENA countries. Using the Generalised Method of Moments (GMM) and Random Effects, we found that Big-4, Coaudit, audit committee size, and audit committee independence restrain earnings management practices of Islamic bank managers. In contrast, audit committee mechanisms do not influence earnings management practices in conventional banks. We also found that the extent of earnings management is lower in Islamic banks operating in countries experiencing turmoil as compared to conventional banks. Using the T-test and the Wilcoxon Signed-ranks, we found that the audit quality in conventional banks is lower compared to Islamic banks. Our findings have implications for policymakers since it helps them to enhance the regulations regarding audit quality and accounting standards. It also provides helpful insights into the determinants of earnings management in both conventional and Islamic banks operating in MENA countries.
Do Islamic banks use loan loss provisions to smooth their results?
Journal of Islamic …, 2010
Purpose -The paper seeks to examine income smoothing practices in Islamic banks. It first focuses on detecting income smoothing practices. It then seeks to test whether loan loss provisions (LLPs) are used for earnings management purposes. Design/methodology/approach -The paper explores income smoothing practices on a sample of 66 Islamic banks over the period 2001-2006 using Beidleman's and Eckel's coefficients. Data are obtained from the Bankscope database. To test the use of LLPs to smooth Islamic banks results, a regression model was developed and tested. Findings -The results provide evidence on an extensive use of income smoothing by Islamic banks. More than 75 per cent of the examined banks have a determination coefficient between 0.5 and 1 and 44 per cent have a variation coefficient less than 0.5. However, income smoothing is not achieved through LLPs. The variable earnings before taxes and provisions are not significant in all model specifications. The paper advances that these smoothed incomes are derived rather by the use of profit equalization reserve (PER) and investment risk reserve (IRR). The finding is contradictory to the widespread view stating that those mechanisms are designed to stabilize rewards attributed to investment account holders.