Discretionary provisioning practices among Western European banks

Abstract

PurposeThe purpose of the study is to investigate whether discretionary ‘loan loss provisioning’ by Western European banks is driven by income smoothing or credit risk considerations.Design/methodology/approachTo test the income smoothing hypothesis, the study uses ordinary least square regression to examine the relation between loan loss provisions and earnings before tax and loan loss provisions in the post-financial crisis period.FindingsThe authors find evidence that discretionary provisioning by Western European banks is driven by income smoothing incentives in the post-financial crisis period, particularly, among listed banks. Also, it is observed that discretionary provisioning is significantly influenced by credit risk factors, mainly, non-performing loans and loan growth. Also, it is found that discretionary provisioning by Western European banks is procyclical with fluctuations in the economic cycle. Overall, the implication of the findings is that discretionary provisioning among Western European banks is driven by both income smoothing and credit risk considerations.Originality/valueThis study focus on banks in Western Europe in contrast to prior European studies.