Accounting Discretion and the Market Disciplining of Bank Risk-taking Behavior: An Assessment of the Effectiveness of Egyptian Banking Reforms from an Accounting Perspective

Abstract

The purpose of this study is to empirically delineate significant economic consequences associated with observable differences in discretion permitted to banks under the existing Egyptian Banking Act. More specifically, the study investigates whether accounting discretion is associated with earnings quality and risk-taking in the Egyptian banking sector. In light of this increased accounting discretion caused by the banking reforms, study questions the extent to which the Egyptian banking reforms facilitate market disciplining of banks. Based on a sample of 46 banks providing 634 bank-quarters over the period 2000-2015, the results indicate that, during non-crisis (crisis) years, bank managers smooth out earnings leading to higher quality earnings but also to higher (lower) earnings volatility and (lower) bank risk, consistent with managerial efficiency and not managerial opportunism explanation of accounting discretion. It is concluded that the economic reforms created conditions whereby bank earnings attributes are improved but where prudential market monitoring and oversight over bank risk-taking behavior may suffer.