Bank Income Smoothing in South Africa: Role of Ownership, IFRS and Economic Fluctuation

Abstract

We examine the determinants of the use of loan loss provisions to smooth income by banks in South Africa. More specifically, we examine the influence of ownership, IFRS disclosure rules and economic fluctuation on the income smoothing behaviour of South African banks while controlling for the traditional determinants of bank income smoothing via loan loss provisions. We find that South African banks do not use loan loss provisions to smooth income when they are (i) undercapitalised, (ii) have large non-performing loans and (iii) have a moderate ownership concentration. On the other hand, income smoothing is pronounced when South African banks are rather (iv) more profitable during economic boom periods, (v) well-capitalised during boom periods (iv) and is pronounced among banks that adopt IFRS and among banks with a Big 4 auditor. We also find that banks use loan loss provisions for capital management purposes, and bank provisioning is procyclical with economic fluctuations. Bank supervisors in South Africa should monitor the bank provisioning practices in South Africa closely to ensure that loan loss provisions are not used as a substitute bank capital. Banks in South Africa should not use sufficient provisioning as a substitute for sufficient bank capital. Secondly, the evidence for procyclical bank provisioning shows that provisioning by South African banks reinforce the current state of the economy and might compel bank supervisors in South Africa to consider the adoption of a dynamic provisioning system that is already adopted by bank supervisors in Spain, Peru, Uruguay, Colombia and Bolivia.